Apple and Sirius XM Aren't Killing Pandora

Pandora (NYSE: P  ) got what was -- on the surface -- the most embarrassing type of analyst upgrade yesterday. MKM Partners analyst Rob Sanderson is raising his rating on shares of the leading music streaming service from neutral to buy; but at the same time, he's slashing his 12-month price objective from $39 to $32.

It may come off as a mixed message, but that's only if you haven't eyed the stock's chart. Shares of Pandora nearly tripled last year, but they started off the week 44% below where they were when they peaked just two months ago. A price target of $32 may have been insulting when Pandora was trading north of $40 in March, but it represented a juicy return of better than 40% in a year when Sanderson made the call on Monday morning. 

Sanderson argues that Apple (NASDAQ: AAPL  ) isn't making a dent in Pandora's model with the copycat iTunes Radio service it introduced nine months ago. He also points out that Pandora is about to overtake Sirius XM Radio (NASDAQ: SIRI  ) in terms of listener hours.

Apple investors don't need to take it personally. There's a reason why Apple is reportedly about to announce a $3.2 billion deal for Beats Music parent Beats Electronics. Sirius XM investors also don't have to be worried. Pandora may be growing faster, but Sirius XM is the one generating the revenue and consistent profitability.

That's important. Sirius XM should top $4.1 billion in revenue this year. Sanderson sees Pandora ringing up $916.4 million in revenue for all of 2014. Pandora may have three times as many active listener accounts, but ad revenue is no match for the predictably steady trickle of subscription revenue.

Despite having a third as many active accounts, MKM Partners estimates that subscribers tuned in for 17.4 billion hours across Sirius XM's channels last year. That compares to Pandora reporting 16.7 billion hours in 2013. It's close, but Pandora is growing faster. In fact, back in 2011 Sirius XM was generating twice the amount of listener hours as Pandora. At that rate this could be the year that Pandora overtakes Sirius XM in total listenership. 

In theory, it doesn't matter. If both companies are growing -- and they are -- that's fine. They are gaining at the expense of terrestrial radio, and benefiting from the trend where music fans are consuming more now that they have greater control to fine tune what they hear. 

Sanderson isn't naive. He realizes that the online music market is about to get more competitive. Sirius XM and Pandora accounted for 85% of the non-terrestrial radio listening last year, and that will shrink in the coming years as Internet radio providers get smarter about making the most of connected cars. However, the pie is still expected to keep growing to the point where both Pandora and Sirius XM will keep growing. 

Sanderson sees Pandora earning a profit of $0.59 a share next year on $1.14 billion in revenue. The top-line growth and dramatic bottom-line surge will come not as a result of a growing user base, but primarily through Pandora getting sponsors to pay more to reach its mobile audience. There's room for Apple to carve out a niche here. There's clearly room for Sirius XM as it controls its satellite radio monopoly. However, Pandora will likely continue to be the volume leader in terms of content consumed once it takes the lead this year for some time. A lot of players may be making music at the same time, but this doesn't have to be a cacophony.

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