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The Pros and Cons of Pandora Media, Inc.'s Ad-Free Day

By Steve Symington – Sep 5, 2015 at 3:00PM

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Here's why the music streaming service is offering 24 hours of ad-free listening on Sept. 9 -- and how it could backfire.

This coming Wednesday, Sept. 9, 2015, Pandora Media (P) will celebrate its 10th anniversary. To mark the occasion, which Pandora is affectionately dubbing "Listener Love Day," the music streaming specialist is thanking its listeners with one full day of ad-free tunes.

"For 24 glorious hours," joked Silicon Beat writer Patrick May earlier this week, "I can listen to my Pandora app without wanting to intermittently throw my phone out my car window."

To be fair, those ads are necessary for Pandora's service to exist in its current state. Even as revenue in the second quarter rose 30% year over year to more than $285 million, the company has yet to achieve sustained profitability as it works to more effectively monetize its massive base of nearly 80 million monthly active listeners. Based on generally accepted accounting principles, all that revenue translated to a net loss of just over $16 million last quarter. Still, Pandora is doing well in Wall Street's eyes; on an adjusted basis -- which notably excludes stock-based compensation -- Pandora achieved net income of $11.6 million, or $0.05 per share, which absolutely trounced expectations and sent shares up nearly 15% the day after the report. 

The pros
But at the same time, it seems naive to say Pandora's kind gesture is entirely selfless.

Pandora is going ad-free for a day in celebration of its 10th anniversary. Credit: Pandora Media.

For one, Pandora management has continually stressed that while the number of active listeners is important, even more crucial to Pandora's success is ensuring each listener remains loyal to the service. Last quarter, evidence of that increasing loyalty continued to surface as total listener hours grew 5% year over year to 5.3 billion, outpacing the more modest 4% growth in the number of active listeners.

In addition, May's comical celebration above brings up a good point: Many Pandora listeners are willing to endure the advertisements that come along with its compelling free service, but they certainly don't enjoy them. So I'd be willing to wager Pandora is using Listener Love Day to not only build loyalty, but also demonstrate to ad-supported listeners the value of its Pandora One subscription service, which offers features including ad-free listening, more skips, and premium quality audio for $4.99 per month.

The allure of adding paid subscribers is obvious; though only four million (or roughly 5%) of Pandora's total active listener base has opted for Pandora One, subscriptions were still responsible for driving more than 19% of Pandora's total revenue last quarter. And paid subscribers offer a predictable, recurring source of sales that help offset the typical ebbs and flows of the advertising market. 

The cons
On the other hand, this gesture of goodwill could be fairly costly for Pandora if listeners don't sign up as expected. Advertising revenue comprised roughly 81% of last quarter's total. And Pandora's guidance for the third quarter calls for revenue of $310 million to $315 million. With 92 days in the current quarter to reach that goal, this 24-hour advertising hiatus could shave as much as $3 million off Pandora's top line -- a small sum at first glance, but possibly enough to be a determining factor for whether the company meets or misses our fickle market's expectations when the next quarterly report rolls around.

What's more, if many ad-supported music grazers realize the grass might be greener on the subscription side of the fence, it could draw attention to the paid services of up-and-coming competitors. Most notably, Apple (AAPL 1.56%) continues to offer free three-month trials of its Apple Music service. Though to Pandora's credit, management told investors during their latest conference call that Apple Music's widely anticipated launch in June was essentially a non-event.

"[W]e aren't seeing any meaningful listener impact at this time," Pandora Brian McAndrews insisted of Apple Music, "and we don't expect any long-term meaningful impact, either."

All things considered, however, these cons admittedly discount the possibility that even a small fraction of Pandora's current ad-supported listener base converts to paid subscribers as a result of Listener Love Day. If that happens -- and even ignoring the goodwill gesture this move represents -- Pandora investors will likely be more than happy with the end result.

Steve Symington owns shares of Apple. The Motley Fool owns and recommends Apple and Pandora Media. 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.

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