Photo: BMO Capital Markets
Internet radio leader Pandora reported Q3 earnings on November 22. The numbers were slightly better than analysts’ printed estimates.The company’s revenue and active user growth are decelerating, but they remain very strong.
Listener hours, the best usage metric, more than doubled year over year, as the average Pandora user consumed more hours of music.
Mobile usage now accounts for 70% of Pandora’s total usage. The company’s revenue, meanwhile, is still derived primarily from web-based listening, which generates higher revenue per hour. One of the company’s challenges going forward will be to increase the revenue per hour it generates from mobile listening.
Content costs (music royalties), the key factor in the company’s model, came in slightly better than expected at 50% of revenue. Pandora’s ability to drive these costs down over time will likely determine whether the company just ekes out a living or eventually becomes very profitable. The larger Pandora gets, the more leverage it will have over the music labels, so we think the odds of Pandora being able to drive royalty costs down are good.
The company says it is not seeing any impact from the US invasion of Spotify and recent launches of new online radio services like ClearChannel’s IHeartRadio, but the slowdown in active user growth will stoke fears about this new competition.
Ultimately, Pandora’s real competition is terrestrial and satellite radio, and here, the company is absolutely killing it. Pandora now accounts for an estimated 4% of total US radio hours. And its customised model–radio stations that play music you like–should continue to lure users away from traditional radio.
Some key numbers from the quarter:
- Non-GAAP EPS: $0.02 versus an expected loss of $0.01.
- Revenue: $75M, up 99% year over year, vs. consensus of $71.6M. The vast majority, $66 million, was advertising revenue, which rose 102% year over year, a modest deceleration from prior quarters. Subscription revenue of $9 million rose 80% year over year, a sharper deceleration.
- Net income: $638,000 compared to $1.1 million during the same quarter last year.
- Q4 EPS Guidance: Pandora said it expects to lose $0.02-$0.04 per share in the fourth quarter.
- Q4 revenue guidance: $80-$84 million, which calls for healthy sequential growth.
Pandora revenue and user growth is extremely impressive. The company’s near-term profits will likely continue be limited by several key investments:
- “Investing in the topline”: Pandora needs to invest in its salesforce to drive more revenue. As it wants to capture radio ad spending, it’s going to have to invest in a local salesforce, which is very expensive.
- Mobile advertising: Pandora still makes most of its money from advertising on the web, despite 70% of its “hours” being consumed on mobile devices. Most of its user growth is coming from mobile, but ad prices tend to be lower in mobile advertising.
- Content costs: Like all other mobile players, Pandora is at the mercy of content owners. Right now, 50% of Pandora’s revenue goes right out the door to music labels. The good news is that the company is gaining leverage here–content costs were better than expected in the quarter. If this continues, the company should soon be very profitable.
The biggest challenge the company faces on the revenue side, meanwhile, is that mobile listening currently contributes less revenue per hour than web-based listening.
According to Jordan Rohan of Stifel Nicolaus, Pandora’s web-based usage rose 12% year over year to 380 million hours, and web-based revenue-per-hour rose 19% to $66.
Mobile hours, meanwhile, rose a staggering 164% to 556 million. Revenue-per-mobile hour, meanwhile, rose 59% to $14.
Revenue per mobile hour is rising rapidly, which is encouraging, but there’s still a huge delta between web-based revenue and mobile revenue.
Photo: BMO Capital Markets
There’s one thing Pandora has which is impressive: huge growth and huge opportunity. Pandora has been growing at an amazing rate, as the charts above from Edward Williams at BMO Capital Markets show.It even showed a small EPS profit this quarter, and JP Morgan expects Pandora to be EBITDA-profitable next quarter, according to a note this morning.
More importantly, as Pandora gets deeper into mobiles and gets embedded into cars, it has an opportunity to eat the enormous radio market, as the chart at right shows.
Here’s an excellent chart of Pandora’s hours and active user growth, from Edward Williams at BMO:
Photo: Edward Williams, BMO
THE BOTTOM LINE:
- Pandora continues to grow extremely rapidly, taking share from terrestrial radio competitors
- Mobile usage is growing much faster than web-based usage, which presents a challenge from a revenue perspective: The company generates higher revenue-per-hour from web-based listening than mobile.
- New competition from Spotify and other companies may be beginning to bite into Pandora’s growth. This will be a key factor to watch.
- Music royalties remain the key variable in the company’s business model: If Pandora can drive royalties down as a percentage of revenue as it grows, it will likely be very profitable. If not, it will only eke out modest profits.
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