The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Before the market open on Wednesday, Pandora (NYSE:P) released its latest monthly audience metrics, reporting solid figures for the month of May. Listener hours were 1.73 billion, up sequentially from 1.7 billion last month and 1.35 billion last year, when the monthly cap on free mobile listener hours was in place. Our model forecasts 5.05 billion listener hours for the June quarter, up roughly 5 percent sequentially; at 3.43 billion, the company is on track to deliver 5.15 billion-5.2 billion hours for the quarter.
Listener hours per day decreased to 55.8 million in May from 56.7 million in April but were up from 43.5 million last year. Share of total U.S. radio listening decreased to 9.13 percent in May from 9.28 percent last month, but was up from 7.29 percent last year. Active listeners increased to 77 million in May from 76 million last month and 70.8 million last year. We expect listener hour strength over the next several months as in-car integration increases. We also expect revenue per thousand listener hours (RPMs) to trend up, as increased opportunities for local ads and improving measurement techniques increase Pandora’s appeal among advertisers.
May 2014 will be the final month that Pandora discloses audience metrics on a monthly basis after having done so for two years. Going forward, we expect only quarterly metrics releases. According to the company, the monthly metrics were provided to help advertisers make informed buying decisions. As Pandora believes advertisers can now make accurate side-by-side comparisons between the company and a variety of competitors through different measurement tools, it no longer believes that there is a business reason to provide monthly metrics.
Automobile integrations are expected to be a source of hours and revenue growth in coming years. Last month, Pandora disclosed that it has integrations in 135 different car models, including all 10 of the best sellers domestically, and several models in Australia and New Zealand. In addition, one-third of the new cars sold in the U.S. have Pandora integrations, with total integrations increasing to 5 million in January 2014 from 1 million a year earlier. Just under half of all radio listening by Americans occurs in cars, with Pandora’s average monthly listening per user of 22 hours lagging the domestic average of 55-60 hours. In-car listening allows Pandora to capture a captive audience with targeting by demographic that results in higher rates paid by advertisers.
Local advertising represents another key revenue opportunity for the company. According to the company, about two-thirds of the $15 billion in domestic radio advertising revenue is from local advertising. In Q1:14, local represented 20 percent of Pandora’s ads, up from 10 percent a year ago. Pandora does not expect to increase the number of audio ads delivered per hour (six) in 2014. Instead, top-line growth will come from the higher rates that local ads command (rates are 50-200 percent higher for local than for national), strong local sales teams across the country, and increased demand. This increased demand is the result of Pandora’s ability to access and target specific groups of users, as well as from the Media Ratings Council’s accreditation for Triton Digital’s Webcast Metrics Local, among other factors.
Pandora shares continue to trade weakly since the last earnings release in April. Initial Q2:14 guidance was slightly below revenue and EPS expectations, and user metrics, while solid, reflect slowing growth. Q2:14 guidance indicates that growth will be weighted toward the back half of the year, and investors appear impatient as they wait for meaningful EPS growth. Given some moderation of overall user growth, we believe that some investors have become disillusioned with the slow pace of EPS growth for Pandora and some of its Internet peers.
The Justice Department announced a review of the music licensing system for songwriters and publishers. These rules applied to an estimated 7 percent of Pandora’s content acquisition costs in 2013, and any change in the system should have minimal or no impact on Pandora’s royalty rates going forward. The rules do not apply to performers or record labels.
Maintaining our OUTPERFORM rating and 12-month price target of $35. Because we see Pandora users continuing to grow, we think it is appropriate to value the company based on its year-end 2013 number of users. We assign a 15x multiple to our $7 operating profit per user per year and arrive at a value per user of $100. At $100 per user, 75.3 million users at year-end, cash and investments of $446 million, and a share count of 200 million, we arrive at our $35 price target, reflecting continued strong user growth. Pandora operates an advertising-based model and in the past year has seen increases in both the frequency of ads delivered and in overall ad rates. As listener hours grow, we expect Pandora’s revenues to grow at an even faster rate. We are maintaining our $35 price target and think that the risk-reward ratio favors an OUTPERFORM rating.
Risks to the attainment of our price target include increasing competition from larger and more established companies, changes to the royalty rates paid for streaming music and other content, the implementation of data caps by Internet service providers, and the proliferation of native music/radio applications for computers, mobile devices, and other connected devices.
Michael Pachter is an analyst at Wedbush Securities.