Pandora (P) reported disappointing results last week, but management said it missed its own guidance and our expectations on both top and bottom lines because of an inexplicable reduction in spending from retail, telecom and consumer electronics advertisers in December.
Other key numbers weren’t bad. For instance, monthly active users increased 7% over the past year while listener hours increased 20%. Engagement and monetization also improved, leading to strong double-digit growth in both revenue and profits.
But investors appear unsure about the amount of premium the shares deserve (its current PEG of 13.7 is still much higher than the industry’s 1.5). And they aren’t to blame because there’s significant opportunity out there.
Pandora is a prime beneficiary of the shift in preferences from recorded music to digital downloads and from terrestrial radio to digital radio. The growing number of mobile devices, particularly smartphones, has increased demand for anytime-anywhere, all-you-can-eat music. A recent comScore report shows that 79% of online radio was consumed on smartphones with another 16% coming from tablets.
This new world of music operates in quite a different way. For one, record labels get paid a fraction of a dollar per stream rather than the album value at the outset. But because users (especially fans) listen a number of times, this adds up.
Users on the other hand, subscribe for ad-free music or opt for “free,” ad-supported plans. While subscription-based listening will not go away, the “ad-supported" variety is more ubiquitous. As a result, the demand for audience analytics to identify user preferences has become extremely important.
The last year has seen streaming companies like Spotify grab analytics firm Echo Nest and Beats Music pick up TopSpin Media (before it got acquired by Apple). Apple (AAPL) in fact went a step further, supplementing the acquisition with that of another music analytics company called Semetric. Pandora didn’t go for acquisitions, announcing its internally developed analytics tool called AMP last October.
A platform with happy content providers and users is also popular with advertisers and Pandora is the farthest along in this race.
Apple’s moves are still unclear although the company is expected to make a splash sometime this year. Apple has leverage (satisfied affluent users, credit card information, Beats hardware and analytics capabilities). So it could capture a chunk of the market quite rapidly.
But let’s not get too negative: Android still accounts for 80% of the market, so an OS agnostic service may be welcomed by many. Google (GOOGL) has its own ad-supported YouTube and subscription service Music Key, both of which compete with Pandora.
Management was however upbeat about Pandora’s market position during the earnings call last week when they announced that Pandora’s share of total radio listening hours moved from 8.6% a year ago to 9.7% this December. Its payments to rights owners jumped 34% in 2014 to $439 million (similar to its own revenue growth rate). Commissions on subscriptions to Google and Apple were $8.9 million (14% of marketing costs).
eMarketer estimates show Pandora’s digital ad revenue share growing faster (20.9%) than the market’s 16.7% in 2014 indicating advertisers’ growing interest in Internet radio, and particularly, in Pandora. Its mobile share appeared to shrink slightly.
There are a couple of downsides to streaming that investors would do well to keep in mind. The first is the difficulty in controlling user churn, which tends to be high (for the ad-supported version). The second is related to the music business, where artists make the biggest sales in the first few weeks of launch and therefore prefer to stay away from streaming services until sales growth stagnates or decelerates.
Pandora shares carry a Zacks Rank #3 (Hold), similar to Google but not nearly as good as Apple, which carries a Zacks Rank #2 (Buy). Limelight Networks (LLNW) is another company with a good Zacks Rank: #1 (Strong Buy).
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