Pandora Media (P) trades well below its recent highs in the $40 range. The company is strongly positioned in the Internet radio space in spite of strong competitive onslaughts from numerous small and large tech companies in the space. Pandora is growing its monetization efforts and subscription revenue and this will fuel stock price growth.
Leader of the pack
Pandora has effectively weathered a storm of market entrants in the Internet music space and emerged stronger. The company recently reported monthly metrics that set records despite large competitive threats. The company now has 77 million active users and more than 250 million registered users. In May 2014, Pandora's market share of the cumulative U.S. radio listening market stood at 9.13% and its total radio listener hours increased a healthy 28% year-over-year to 1.73 billion hours for the month.
Those are very impressive numbers for the leading Internet radio company, considering the competitive forces in play. Apple (AAPL 5.98%) hiked its efforts in the Internet music radio space with not only its own iTunes Radio but also with its recent $3 billion acquisition of Beats. Apple's iTunes Radio hasn't been as big a hit as many assumed it would be, but it still managed to get around 20 million listeners. The iPhone maker will definitely utilize its marketing muscle to sell Beats Music subscriptions to its global fans.
Another tech giant, Amazon (AMZN 0.81%), unveiled Prime Music, which is an ad-free music streaming service available only to Prime subscribers. Amazon has in excess of 20 million Prime users, so the streaming service can gain momentum. It only has a small music library of 1 million songs, but Amazon intends to grow the music library of Prime Music a lot in the future.
Also, iHeart Radio and Spotify both have very significant offerings in the Internet radio space and both services are bigger than the offerings from Amazon and Apple. Spotify has a presence in 56 markets worldwide along with 40 million active users and 10 million paid subscribers as well. On the other hand, iHeart Radio has more than 18 million songs and 50 million registered users on its platform. In spite of such a cut-throat competitive field, Pandora leads all of them in terms of consumer usage.
Monetization is gaining momentum
In the last quarter, Pandora saw accelerating revenue growth. Pandora's top line increased 69% year-over-year to $194 million, and this was the fastest revenue growth for the company in the last five quarters. Gross margin for Pandora increased dramatically from 17% in the first quarter of 2013 to 37% in the first quarter of 2014, and this margin expansion will pave the way for sustained profitability in the future.
Pandora's total RPMs grew 50% year-over-year to $40.51 in the last quarter, which is a big increase and shows that the company is effectively monetizing its growing user base. In addition, Pandora is growing its sales force to address local ad markets and in the process ramp up its monetization further. The company is also showing video ads on its platform, which are a great monetization tool as well. Pandora also reported 5 million active users in autos and that might result in more monetization opportunities and give the company an opportunity to steal ad market share from terrestrial radio.
Shift toward subscription dollars
Pandora now has roughly 3.5 million paid subscribers and even implemented a modest price increase of $1 to push the monthly price to $4.99/month to maintain pace with its rising content costs. However, the company will grandfather in existing customers, and it is only pushing the price increase to new Pandora One customers starting in May 2014. And the company is growing its subscription revenue substantially as a result.
In the last quarter, subscription revenue grew 192% year-over-year to $53 million. While that was from a small base, the price increase will ensure sustainable revenue growth. In addition, subscriptions are increasingly making up a larger portion of Pandora's total revenue.
In the first quarter of 2012, subscription revenue made up 14% of Pandora's total revenue and in the first quarter of 2014, subscription revenue made up roughly 28% of total revenue. This is a big positive for Pandora because subscription revenue is inherently more stable and predictable than other types of revenue, and as a result investors are willing to attach higher valuation multiples to companies that have predictable revenue streams.
Going forward
Pandora has a great competitive position as the top dog in the Internet radio space. Growth in subscription revenue and heightened efforts to grow the monetization of its user base will push the company toward profitability.
Canaccord has a Buy rating on Pandora with a $43 price target, which implies big upside from current levels. The firm cited strong business momentum as a reason for the price target. In addition, some of the cash-rich laggards in the Internet radio space might be very tempted to make an acquisition attempt on Pandora due to its robust positioning. Pandora has immense upside in the future.
