Pandora (NYSE:P) is trying to get its groove back. And it may be on the right track, but one key component in its business model could put a halt to any rebound. 

In March 2017, Pandora unveiled Pandora Premium (its ad-free subscription service) to select listeners and opened it up to the American public in April. Premium has all the personalized features of Pandora and its Music Genome Project, except no ads. Since making the decision to focus on its premium users -- who pay $9.99 per month -- it has quickly surged to the top or near the top of the lists of the highest-grossing iPhone and Android apps:

Top 10 grossing iPhone apps in the US as of August 2017.

Data source: Prioridata via Statista.

The top 10 android apps in the US in September 2017.

Data source: Prioridata via Statista.

Unfortunately for Pandora investors, download rankings aren't the best way to judge the stock.

Far more important is average revenue per user (ARPU) minus subscription licensing costs per paid subscriber (LPU). What the company takes in from paying members minus what it pays for the music those people listen to. Ever since Pandora introduced its Premium option, its margins per subscriber have shrunk, and therein lies the problem.

We'll make it up on volume!

There's an old story about a factory that lost money on every single widget it produced. The variable costs were just too high. When a company's accountant points out that the business is losing money on each widget, the owner replies, "Don't worry -- we'll make it up on volume!" Of course, that doesn't actually work.

Like the widget factory owner, Pandora is trying to accrue more paying members, but it can't earn a decent profit because its content costs are too high. Take a look at this table for average revenue per user (ARPU) and subscription licensing costs per paid subscriber (LPU), metrics management started reporting in the fourth quarter of 2016.

 Metric Quarter Ended 9/30/2016 Quarter Ended 9/30/2017 6 Months Ended 9/30/2016 6 Months Ended 9/30/2017
ARPU N/A $5.58 N/A $5.05
LPU N/A $3.87 N/A $3.33

Data source: Pandora. 

A woman wearing headphones and holding a cup of coffee while outside.

Image source: Getty Images.

After doing some simple math, we realize what management has surely concluded as well: There is a disconnect between content costs and premium user payments. The comparison is limited since we only have a few quarters of these metrics, but what we do know is this: For the first six months of this year, licensing costs per subscriber were 65.94% of average revenue per paid subscriber. But for the third quarter, the most recent period we have to work with, this figure has trended up to 69.35%.

Unfortunately, Pandora pays the artist (or the artist's label, more accurately) for each and every song premium subscribers listen to. The bulls are no doubt hoping for some help from Sirius XM, which recently invested in Pandora and may give the company leverage in future negotiations with content providers. Were it to lower its content costs, Pandora very well could be a dream stock to own. But the road will be long. For now, I remain on the sidelines, watching its ARPU and LPU figures closely. 

Sean O'Reilly has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Pandora Media. The Motley Fool has a disclosure policy.