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Should Pandora Be Worried About Spotify?

By Connor Foreman - Dec 17, 2013 at 8:30PM

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Spotify is growing and creating a free streaming program for mobile devices. With Apple and Google also entering into this space, what should Pandora investors know.

Spotify announced this week that it will launch its services in 20 new countries and will create a new free streaming program for mobile device users. This begs the question: Should Pandora (P) stockholders be worried?

Pandora has made its free mobile device app the main source of user generation in the past and has leveraged its mobile user base to gain a foothold in the sector with almost triple the membership of Spotify (70.9 million vs 24 million). Spotify previously charged $10 per mobile device customer, and investors are weary that this move to free mobile streaming will hurt Pandora's mobile user base, which is responsible for 80% of its users.

Since the official announcement from Spotify that the company will be expanding into 20 new countries and will offer free mobile usage, Pandora stock has dropped over 8%. Although seemingly large, it is less significant after you notice that Pandora's stock has risen over 200% since December 2012.

Prior competition
This year, there has been an increase in competition for the Internet radio company, with Apple's (AAPL 0.17%) iTunes Radio released in September. The release of iTunes Radio has had a minimal effect on Pandora, as the user base dropped from 72.7 million in September to 70.9 million in October. Plus, the loss primarily consisted of only occasional users, as total hours listened actually rose in that time from 1.38 billion to 1.46 billion.

Additionally, Bloomberg reported that Pandora has seen an increase in market share since the iTunes Radio launch, up from 7.77% to 8.06%.

Third-quarter financials
This slight drop in users for Pandora hardly affected its bottom line, as the company's revenue comes primarily from advertising to frequent listeners. Mobile advertising revenue grew to $104.9 million, increasing 58% compared to the same quarter last year, and the company took in more revenue from subscriptions in 3Q 2013 than in all of the first three quarters of 2012.

In addition to revenue growth, Pandora has seen a 20% year-over-year increase in listeners, even with the iTunes Radio decrease. Listener hours, the biggest advertising driver, was up to 4.18 billion, a 17% increase from 3Q 2012.

Pandora, currently third for largest mobile advertising revenue behind Google (GOOGL -1.34%) and Facebook (FB 1.18%), could increase revenue with one simple step -- increasing the advertising per hour. Currently, free users are shown advertisements once every 30-60 minutes, depending on the station, with ads typically lasting 15 seconds. This equates to one minute of advertising every hour. If Pandora increased the frequency of ads to two to three minutes per hour, revenue would be increased proportionally.

If it were to increase advertising, acquiring new advertisers wouldn't be a concern. Pandora finds it relatively easy to attract the sponsors because it can use its Music Genome Project to directly predict the type of subscriber listening to each radio station, allowing marketers to directly target ads at a specific demographic.

Brand loyalty
Pandora has also created forced brand loyalty within its website because, as users give "thumbs up" and "thumbs down" ratings to songs, they get a progressively more personalized radio station, prompting them to stay with Pandora. In addition, even new users without the previous history have stated that Pandora gives the best all-around selection as seen in a Forbes article by Amadou Diallo, where he tests iTunes Radio and Spotify against Pandora.

Spotify's move to encroach on Pandora's 56 million active mobile users has given a slight spook to investors. While you will have to wait for the implementation to see how it affects the companies, it is clear that Pandora has seen tests similar to this before, yet has continued to grow revenue. With the continued growth of metrics from listener hours to mobile advertising revenue year-over-year, despite numerous competitors, it seems that this play by Spotify will do nothing to weaken Pandora's outlook moving forward.

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