Pandora: Business or Non-Profit?

Analysts estimate traditional radio advertising market in the U.S. to be worth $14 billion-$16 billion. Internet players like Pandora (NYSE:P) are lauching a full-fledged attack on this advertising market and are seeing good results. Today, Pandora is ranked as the largest radio station for listeners aged 18 and above in more than 25 markets in the country. It is the biggest radio station in the New York and Los Angeles markets. Among online radio stations, Pandora commands an impressive 75% market share.

Pandora Beat Market Expectations
Pandora’s Q2 revenues grew 51% over the year to $101.3 million beating the market expectations of $100.9 million. Increasing content acquisition costs pushed its losses higher as it reported a break even quarter compared with earnings of $0.02 reported a year ago. The Street was looking for a loss of $0.03 per share.

Revenue growth in the quarter was driven by an increase of 53% in advertising revenues, which brought in $89.4 million in the quarter. Subscription and other revenues grew 36% over the year to $11.9 million. Pandora’s mobile initiatives are delivering good results, and revenues from the mobile devices grew 86% over the year to $59.2 million. Overall listening hours for the internet radio station grew 80% over the year to 3.30 billion. The number of active listeners grew 48% to 54.9 million. In July 2012, Pandora accounted for 6% of U.S. radio listening hours, compared with 3.5% a year ago.

Pandora expects to end the current fiscal with revenues of $425-$432 million compared with earlier estimates of $420 million-$427 million. The company is anticipating a loss of $0.04-$0.08 for the quarter. The market is projecting the year’s revenues at $424.2 million with a loss of $0.12 per share. The company projected current quarter revenues to be in the range of $115 million-$118 million with EPS to be $0.00-$0.01. The Street was modeling revenues of $114.4 million and a break even quarter.

Pandora’s Rising Costs
While Pandora does have a strong following, it is troubled by its rather high cost structure. Content acquisition costs remain high, and during the last quarter the company spent nearly 60% of revenues on content acquisition and royalty related payments. Pandora’s current fee structure is based on discounts applied to a rate set by federal statute. Music royalties are determined by intermediary bodies, and Internet players have limited negotiation room. Pandora’s existing terms will be up for negotiations in 2014. Till then, for each song that a listener tunes in to, Pandora has to pay the artist a fee. Analysts aren’t hopeful that Pandora will turn in any profits. However, to counter the rising royalty costs, Pandora is growing its advertising business through deployment of sales teams to help compete with local radio stations.

Pandora Resumes International Expansion
Till a few years ago, Pandora was present in international locations. However, because of music licensing requirements, it stopped its international operations. However, after a period of five years, it is again operational in Australia and New Zealand. In July of this year, it launched its free beta edition in these countries. The ad-free premium service is priced similar to the American pricing model at US$3.99 per month of US$36.00 per year.

Apple’s Take on Pandora
The high-growth online music industry has attracted the interest of Apple. Apple is already working with several record labels to launch its own streaming service soon. Apple already has a strong music industry presence through their iTunes store. However, online music streaming poses its own challenges, the biggest one being that of agreeable royalty and content costs. Earlier, Apple had tried its own music service, but had dropped the idea because of these high content costs. It is hoping to be able to negotiate better deals this time. If Apple’s service were to go live, Pandora would face tough competition. Though Apple’s radio will not be available on Android devices, Pandora will stand to lose a big share. Nearly a third of the U.S. mobile devices are the iPads and iPhones, a market that Pandora may end up losing to Apple.

The market is waiting to see what happens next with Apple’s radio service. This concern has also sent Pandora’s stock to relatively low levels of $10.58, with a market capitalization of $1.79 billion. It touched a high of $26.00 soon after its listing in June 2011. The stock has recovered from a low of $7.83 it touched in April of this year.

I am still wondering whether Pandora is a business, or should it become a non-profit!