Can You Make Money in Music?

The digital music business has been really tough to make money in. I often scratch my head and wonder whether anyone can make money in this business. We cover the usual suspects, including the Swedish music streaming service, Spotify. As we have discussed earlier, Spotify remains unprofitable despite international reach, revenues of $889 million projected for the current year, and valuation of close to $4 billion. Let’s look at Pandora and how it is faring in the face of strong mobile advertising forecasts, rapid subscriber growth, and other positive trends.

A recently released report by eMarketer on U.S. mobile advertising projects that ad spending will grow faster than previously expected. Overall spending on mobile advertising in the country is projected to grow 180% in 2012 to more than $4 billion. Growth is estimated to continue in the years to come. By 2016, U.S. mobile ad spending market is projected to be worth $21 billion. While Google and Facebook will continue to command the majority of the ad revenues, other players are also gaining in importance. eMarketer expects Internet music station, Pandora (NYSE:P), to be the third-largest revenue generator, with mobile ad revenues growing to $496 million from $120 million last year.

Pandora’s Financials
Pandora’s Q3 revenues grew 60% over the year to $120 million, beating analyst expectations of $117 million. Advertising revenues grew 61% to $106.3 million and Subscription revenues grew 52% to $13.7 million. Non-GAAP EPS of $0.05 was also ahead of the Street’s target of $0.01 for the quarter.

Pandora continued to see impressive growth in user statistics. During the quarter, the number of listener hours grew 67% to 3.56 billion. Mobile use has been a strong growth driver. Although mobile listener hours grew 85% over the year, improved monetization of the segment helped drive revenues up 112% to $73.9 million. Pandora’s market reach within the U.S. is growing. As of December 2012, Pandora recorded a market reach of 7.19% of total U.S. listening hours, which was attributed to a 41% growth in the number of active listeners. The company ended the last calendar year with 67.1 million active listeners.

For the current quarter, Pandora projected revenues of $120 million-$123 million with a loss of $0.06-$0.09 per share. The Street was projecting revenues of $130.3 million with earnings of $0.02 per share. Pandora projects fiscal 2013 revenues to be in the range of $422 million-$425 million with a loss of $0.09-$0.12 per share, compared with market estimates of $429.2 million in revenues and a loss of $0.06 per share.

Pandora’s Mobile Focus
To continue to expand its mobile reach, Pandora recently released Pandora 4.0, an upgraded version of its existing mobile app. Pandora 4.0 provides a uniform interface to users irrespective of the mobile OS. Both Android and iOS apps will have the same features and offer expanded functionality such as a detailed personal music profile and the ability to share music choices on various social networks. In addition, the app offers new abilities to advertisers such as unified sponsorships across all mobile devices. Pandora entered into an agreement with Microsoft as well, and its app will be released for Windows phones in the current year.

Pandora’s International Expansion
Pandora is also spreading its geographic footprint. Recently it announced the availability of their music in Australia and New Zealand. In Australia, besides the mobile app, it is also available through Holden, GM’s subsidiary, as part of MyLink, the first in-car system in Australia that will be fully compatible with Pandora.

Not only will market expansion help Pandora add to its listener hours, but also help to grow earnings. Royalty fees for music varies by country. Pandora is still awaiting a decision on the Internet Radio Fairness Act in the U.S. While it waits, it pays as much as 50%-60% of revenues in royalty charges. But in New Zealand, Pandora is projected to pay royalty charges of less than 25%.

Pandora’s stock is trading at $10.85 with a market capitalization of $1.85 billion. It touched a high of $15.25 in March 2012.

The market conditions look rosy for Pandora. Mobile advertising growth, fueled by increasing market share both within and outside the U.S., will help the company. But things aren’t as simple as that: Pandora needs to improve the monetization of its user base of more than 67 million. At the end of the recent quarter, subscription revenues accounted for only 11% of the quarter’s revenues, suggesting a rather poor premium subscriber base. The company may count on international expansion to manage growth despite high royalty costs, but it cannot ignore the scale that U.S. offers compared with smaller nations like New Zealand.