Pandora Media (P +0.00%) has been one of the more hotly-debated stocks in recent months, and shares have been exceptionally volatile, as seemingly every week, a new piece of news comes out changing the investing thesis. The market doesn't seem to know what to make of the fledgling Internet DJ, and many believe that, while the service is excellent, the business model remains suspect. In our new premium research report on Pandora, I provide a 2000-word analysis of Pandora's key challenges and prospects, which seeks to answer, among other questions, if Pandora is built to last. What follows below is an excerpt on the audiophile's opportunities:
The Opportunity
There's little reason to doubt the popularity of the service. In its last fiscal year, Pandora streamed 8.2 billion hours of radio, and had 47 million active users -- those users who have logged on in the last 30 days -- out of 125 million registered users. Membership is still growing fast, with 1.15 billion hours streamed in September 2012, up 67% from a year ago, and active users now number 58.3 million.
But, while Pandora, the service, has attracted legions of devotees, Pandora, the stock, has received mostly criticism since it went public last June. With shares now worth only about half their initial value, and the company still unprofitable, it's easy to see why. Detractors insist that the largely advertising-based model can't compete with the likes of Sirius XM Radio (SIRI +0.00%) or streaming peers like Spotify, which are more reliant on subscriptions. Investors need to remember, though, that this industry is still in its infancy, and there are opportunities galore for a player like Pandora. Let's take a look at a few of them.
- In the dashboard.
Satellite radio provider Sirius XM's success has come largely from partnering with automakers, so that its radios come pre-installed in the dashboard. Those radios are available in approximately two-thirds of the vehicles sold in the U.S., whereas Pandora is just beginning to penetrate the market. The streaming service is available through at least 14 different vehicle manufacturers, and six others have signed agreements for future integrations. Considering the average vehicle in the country is now 11 years old, these additions will take time to work their way through the nationwide auto inventory, but should deliver steady increases in usage over that time period. Pandora shares recently jumped when CEO Joe Kennedy said that some automakers were beginning to put a button on the dashboard interface to make using Pandora as easy as using the AM/FM radio. Right now, only 14% of Internet-radio listeners stream from their car. - Local advertising.
Advertising is far and away Pandora's major revenue stream. In fiscal 2012, 87% of revenue came from advertising, as opposed to just 13% from subscriptions, yet the company has only just started targeting the local radio ad market. As it becomes more of a mobile service rather than a desktop service, local radio ads will gain more importance as they replace display ad revenue. In 2010, total radio ad revenue in the country was $17.3 billion and growing by 6% a year. Considering Pandora had a 6.5% share of total U.S. radio listening in September 2012, the company should be taking in at least $1 billion in ad sales every year, and probably more, because their customized radio stations are better suited for targeted ads. However, in its last four quarters, Pandora has only brought in about $300 million in ad revenue. - International.
Pandora derives nearly all of its sales from the United States, but there's no reason the service wouldn't be equally popular in other parts of the world. The company has begun streaming in Australia and New Zealand, and earlier, pulled out of Canada over issues with royalty rates. Obtaining international licensing rights may prove difficult, but as companies like Facebook (FB +0.74%) have shown, there's a bounty of Internet users waiting to be tapped overseas. Pandora could easily double or triple its membership if it is able to successfully penetrate foreign markets. - Internet Radio Fairness Act.
One of the biggest problems Pandora has faced in its efforts to turn a profit is the high content acquisition costs it's forced to pay. Currently, more than 50% of revenues goes to content acquisition because of high royalty rates. When compared to satellite radio provider Sirius XM, which pays about 8% of revenue to royalties, and terrestrial radio, which pays no royalty rates, the disparity seems blatant and anti-competitive.
The Internet Radio Fairness Act, a bill introduced in Congress in September 2012, seeks to remedy this by allowing streaming services to use the same standard that satellite radio does to determine its rates, which are set by a panel of federal judges. Not surprisingly, Pandora has put its full force behind the measure, as founder Tim Westergren has called the anti-Internet bias "absurd." Right now, Pandora must pay a minimum of 25% of its revenue in royalties. Even a modest reduction in rates would be its easiest and quickest path to profitability. If Pandora's content acquisition costs had been 20% lower last year, it would have had an $0.11 EPS profit instead of a $0.19 loss. - Comedy and product diversification.
Pandora will always be primarily a music service, but its rollout of a comedy platform shows its model can work for more than just melodies. The comedy offering, which began in May 2011, allows users to choose a station based on a comedian, and customize it the same way they would with a music station. The comedy platform adds value for the user, and brings Pandora one step closer to offering the broader array of content available from providers like Sirius XM, which gives its users music, comedy, sports, talk radio, news, and weather and traffic updates. It's easy to imagine Pandora continuing to branch out into other spoken-word content, such as podcasts and talk radio, that will make its product even more compelling for the user.
For more insight on Pandora, I encourage you to pick up a copy of our exclusive report on the audio streamer, which also covers the company's risks, key areas to watch, and reasons to buy and sell. Best of all, it comes with a year's worth of free updates to keep you informed on earnings reports and any other breaking news that comes up. To get started with this informative new package right now, all you have to do is click right here.
