2 Reasons to be a Pandora Media, Inc. Bear

The bearish thesis for Pandora includes surging competition and rising content costs.

Jul 7, 2014 at 2:20PM

Internet radio company Pandora (NYSE:P) has seen a slight recovery in its stock price over the past few months. However, the company still faces a couple of big challenges. The company's royalty payments are rising, and as a result Pandora has found it harder to post consistent profits. On the other hand, competition is greatly increasing. These two factors could produce major headwinds for Pandora.

Rate increases
Pandora's rocky business model greatly depends on the fees that it pays to artists. The company continues to see its payments to musicians and artists rise, and as a result it has been harder for the company to report positive net income consistently.

In the first quarter of 2014, Pandora's content acquisition cost stood at 56% of revenue and that will likely increase in the future. Pandora hiked the price of its Pandora One service from $3.99/month to $4.99/month because of the higher royalty fees it expects to pay. Pandora's royalty fees paid to performers for subscription listening have risen 53% in the last five years and will increase another 9% in 2015. The complained explained this is why it raised the price of Pandora One. 

As a result, the company will likely see its content acquisition costs rise in 2015. In addition, as the average consumer has an extensive choice among music listening sources, the customer might be reluctant to pay for a Pandora One subscription.

Pandora must also pay roughly 4% of its total revenue to performing rights organizations such as BMI and SESAC. And its payments to performing rights organizations might also increase if the company sees more lawsuits in the future. 

Rising competition
Pandora's competition in the Internet radio category remains on the rise. Even though Pandora is the leader with 77 million active listeners and more than 250 million registered users, a big surge in competition has occurred in the space. 

Pandora's leading competitors in the space, Spotify, iHeart Radio, Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG)(NASDAQ:GOOGL), are all pushing hard to grow their presences in online music services. eMarketer expects U.S. advertisers to increase their spend for online and mobile radio services to $2.04 billion in 2014, a 23% year-over-year increase, and that is likely a major reason why new players have entered the field. In addition, all of the players -- including Pandora -- also offer ad-free paid subscriptions to their users. 

Apple acquired Dr. Dre's Beats and will market it to its global customer base, so it will see an increase in paid subscribers for Beats Music in the future. As a result, Apple will become a much stronger force in the space with Beats Music to supplement iTunes Radio, the ad-supported offering from Apple.

Google, on the other hand, already has the largest music streaming platform in the world with YouTube. Google also offers its Music All-Access service on a paid subscription basis for a fee of $9.99/month. In addition, Google recently acquired Songza, which is a music streaming service that curates music according to users' customized tastes. Since Google has substantial consumer reach with Search and Android, the company can roll out Songza to hundreds of millions of Android devices. In the process, it could see robust consumer adoption of Songza. 

Competition for your car
Last quarter, Pandora stated that it had 5 million listeners in autos. But the company faces extensive competition on that front as well from AM/FM radio, which has more than 200 million weekly listeners, and satellite radio giant Sirius XM, which offers lots of non-music content for its subscriber base of almost 26 million. As a result, Pandora faces competition from various angles and might have a harder time growing its active user base and revenue substantially in the future. 

The takeaway
Pandora is the category leader in the Internet music space, but extensive competition and rising content rates are hampering its moat. The company has to significantly ramp up its monetization per listener hour to stabilize its profit margin, which has been very lumpy. And the growing competition in the space will make it harder for it to increase its total listener count and poses serious challenges to the company.

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Ishfaque Faruk owns shares of Sirius XM Radio. The Motley Fool recommends Apple, Google (A shares), Google (C shares), and Pandora Media. The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), Pandora Media, and Sirius XM Radio. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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