Three months ago, I posed the question of whether Apple's (NASDAQ:AAPL) iTunes Radio would be the "beginning of the end" for Pandora (NYSE:P). While the -60 score on my underperform CAPScall is a clear indication that the market disagrees with my concern, the actual release of iTunes Radio last week warrants a second look at this analysis.
A better customer experience
Thus far, the reviews for iTunes Radio have been quite positive. For example, CNET recently published a review that clearly declares iTunes Radio the superior choice over Pandora, and users of both services can quickly see why. While many initially dismissed iTunes Radio as an imitator, there are a number of reasons both subtle and obvious why it is a compelling option. Here are a few highlights:
- While both iTunes Radio and Pandora provide the ability to create customizable radio stations, iTunes Radio has for existing iTunes users, including seamless access to past purchase and listening data to improve the song selections.
- As CNET noted, Apple's existing agreements with just about everyone in the music industry provide it with a staggering selection of 27 million songs for iTunes radio, which compares to just 1 million for Pandora. The result is a noticeable difference in the frequency that songs are repeated.
- Apple's user friendly interface has a number of simple, yet very powerful features that Pandora does not. A great example that I've discovered through use of the app is the ability to toggle between modes that focus on hits, discovery of lesser known tracks, or a mixture of the two.
- iTunes keeps track of the songs that have played on a user's station, allowing the user one-click access to purchase not only the song that is currently playing but also those that played previously. Similarly, a user can place a song on their wish list with ease.
- Guest DJs and suggested stations provide an excellent starting point for a user looking to try something new or get music streaming quickly.
- Apple's commercial-free version of iTunes Radio is priced at $25 per year, which is both cheaper than Pandora One's $36 per year and also includes iTunes Match cloud storage.
As a longtime user of both iTunes and Pandora, I am hard pressed to find any aspect of the streaming music experience that is superior on Pandora. Even Pandora's long-touted recommendation engine doesn't provide it with an advantage; in an anecdotal test, I found myself pressing the thumbs down button in Pandora far more often than than the "never play this song" button in iTunes Radio.
How big is the threat
To be clear, Pandora is far more ubiquitous than iTunes Radio. While there are hundreds of millions of Macs, PCs, iPhones, iPads, iPods, and Apple TVs in use that have support for iTunes Radio, Pandora goes above and beyond this population with Android-based mobile devices, smart televisions, blu ray players, Roku boxes, and any number of other platforms. So, there are plenty of devices where Pandora remains the best streaming option around. However, it is worth taking a look at just how many Pandora users might be migrating to iTunes Radio.
NPD recently published a few notable statistics. Of Apple's 67 million active iTunes customers, 42% (28 million) are current Pandora users. This group represents just under 40% of Pandora's 72 million active users as of the end of August.
This should be an enormous reg flag for Pandora investors. A staggering 40% of the existing subscriber base has any number of good reasons to abandon or reduce usage of Pandora in favor of iTunes Radio; these reasons vary from already subscribing to iTunes Match (which makes the commercial-free version of iTunes Radio essentially free), a better user interface, or sophisticated interaction with a user's existing music library.
While there is a real threat to Pandora's existing user base, there is even more risk to Pandora's ongoing growth. Apple recently announced that iOS 7 was downloaded to over 200 million devices in the first weekend after release; this staggering adoption rate has already resulted in iTunes Radio being installed on multiple times the number of users of Pandora in just a few days. When iOS users first look to experiment with streaming music, there's a good bet that iTunes Radio will be the starting point.
What does this mean for Pandora?
I am not saying that all users will abandon Pandora in favor of iTunes Radio. Not even all iOS users will make the switch. However, a large number will make that switch, and I expect that to be a significant drag on Pandora's previously strong revenue growth.
It is also important to revisit the profitability of Pandora's business model. This chart tells the story:
Pandora's revenue has exploded in the past couple of years, but the company continues to generate losses as its business model continues to fail to overcome steep content acquisition costs. At some point, Pandora needs to start generating income in order to stay alive.
In contrast, Apple does not need to profit from iTunes Radio. The company has the luxury of making the service a gateway to further iTunes revenues, an enhancement to it iOS ecosystem, or even just a pet project for management. Regardless, the success of Apple doesn't hinge on the profitability of this service; this is a significantly more enviable position to be in than Pandora's life and death struggle to make streaming music profitable.
There's competition everywhere
To make matters worse, Apple is only one of many competitors fighting for user attention. While Pandora boasts that it captured a 7% share of domestic radio listening in August (prior to iTunes Radio's release), that means that 93% of radio listeners use another service. Listeners seeking free, advertiser-supported radio options listen to traditional over-the-air AM and FM radio stations, HD radio, free streaming services such as iHeart Radio, and competing mobile apps such as Spotify.
Meanwhile, the premium radio market is dominated by SiriusXM (NASDAQ:SIRI), whose satellite radio services (and optional streaming service) include premium sports, news, and celebrity content. SiriusXM cleared the 25 million paying subscriber threshold last quarter while reporting record revenue, raised guidance, and a number of other positive financial results.
When you combine the entrance of Apple's iTunes Radio as a direct competitor with existing competition and Pandora's struggles to become profitable, it becomes quite difficult to justify Pandora's market capitalization of $4.5 billion. As a result, shareholders should beware of the incredible amount of risk associated with owning shares of Pandora at today's prices.