Nearly everything is in place for Pandora (NYSE:P) to launch an on-demand music streaming service like Spotify or Apple Music. The internet-radio pioneer has deals in place with two of the three major labels and Merlin, which represents more than 20,000 small labels around the world.
Management held a conference call to discuss its plans for launching an on-demand streaming service priced at the industry-standard $9.99 per month as well as a lower-priced service. It also reaffirmed its five-year outlook of $4 billion in revenue by 2020, and provided some additional detail.
Here's where Pandora sees its business in five years.
How to get to $4 billion in revenue
With the addition of on-demand streaming, Pandora now has three main businesses to generate revenue: its core ad-supported internet radio service, its ticketing service, and its subscription services.
Pandora expects its internet radio business to generate the bulk of the revenue, $2.4 billion. For reference, Pandora generated $933 million in revenue from its ad-supported radio service in 2015.
Pandora's current subscription offering, the $5-per-month Pandora One will become a part of Pandora's subscription segment. Management believes this segment will reach $1.3 billion in five years based on 10% penetration of its expected U.S. listeners. Pandora One currently only counts about 5% of Pandora listeners as subscribers, and it generated about $221 million in revenue last year.
Pandora didn't provide any details on how big it sees its subscriber or total listener base growing over the next five years, but active listeners shrunk significantly year over year last quarter to 78.1 million. Even if all of those listeners were in the United States (Pandora also operates in Australia and New Zealand), that's still less than $1 billion in yearly revenue from 10% penetration with a $9.99 per month plan.
The final leg of Pandora's business is its burgeoning ticketing business led by Ticketfly. Management expects ticketing to bring in $300 million in revenue by 2020. Through the first six months of 2016, ticketing has generated $45 million in revenue, so that's asking for more than 200% revenue growth over the next four and a half years. In order to do that, Pandora will need to take share from TicketMaster and StubHub by promoting tickets to its listeners.
Pandora's outlook seems very optimistic. Even if it doesn't reach its expectations by 2020, there were some very valuable takeaways from management's comments regarding the profitability of the business going forward.
Pandora could make a profit streaming music on demand
Pandora expects its content costs to total just 65% to 70% of total revenue. While the industry standard puts the number at 70%, most streaming services end up paying a much higher percentage of revenue to record labels.
Spotify, for example, revealed that it paid out 83.6% of revenue to labels last year, and that number has been above 80% for the last three years. The additional pay beyond the 70% of revenue comes from upfront fees and guaranteed minimums in Spotify's contracts with the labels.
But Pandora CFO Mike Herring said he has "supreme confidence" that Pandora will be able to reach that target gross margin when asked about it on the conference call announcing the agreements.
That's hugely important for Pandora because it means it won't have to scale the business quite as large as Spotify or Apple Music to generate a profit. Spotify reached 40 million paid subscribers recently, and Apple Music announced 17 million paid subscribers earlier this month. It's still unclear if either service is profitable yet.
But even if Pandora only attracts 10 million or 11 million subscribers -- as its $1.3 billion outlook suggests -- it could still be quite profitable if it's paying significantly less of its revenue out as content costs.
Adam Levy owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Pandora Media. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. 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.