Pandora's Box Unlocked: Are Those Profits Miracle Or Mirage?


Photo: Wikimedia, CC.

Pandora’s Q3 earnings contained a huge surprise: The streaming music “radio” company made $638,000 in net income on the quarter, against expectations.

I’ve previously expressed scepticism that Pandora would ever be profitable because of the way its music royalty costs are locked into a suicide pact with its ad sales revenues: The more users it has, the more advertising it can sell against those pairs of ears. But at the same time, the more ears that listen and the longer they listen, the more songs they hear and the more Pandora must pay out in music licence royalty fees.

There’s nothing CEO Joe Kennedy can do about the size of those royalty fees, which are set to rise through¬† 2015 — to Pandora’s huge disadvantage — unless the company can renegotiate them downward. Royalties are an existential threat to Pandora, basically.The result is that when you plot Pandora’s revenues against its total operating expenses (which include overhead in addition to royalties), the two lines look the same:

pandora 2011

Given that Pandora’s ad revenues and costs rise and fall in lockstep, where did that profit come from?

Here’s one theory: Pandora has somehow found a way to charge its advertisers more. Of the $75 million Pandora made in Q3 revenue, $66 million came from advertising sales, which were up 102 per cent. One clue to this is that Pandora appears to be earning more revenue per user than it used to: In its fiscal Q1 2011 (18 months ago), Pandora got about 53 cents per user. Now it gets about 75 cents:

pandora 2011

Pandora probably didn’t get those extra revenues from its subscription customers. Pandora’s subs business appears to be reaching a plateau:

pandora 2011

Its ad business, however, forms an increasing percentage of its entire business:

pandora 2011

This, then, is the future of Pandora (if it has one). It must extract higher prices per ad from the companies that advertise on its service, or it must run their ads with greater frequency within the Pandora music stream. Whether it can lift those dollar volumes by up to 47 per cent, as required by its royalty contracts, is another question.

SEE ALSO: Angie’s List Needs Fixing: Why This Disaster Area¬†Doesn’t Make Make Money

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