Outlook: Pandora’s December Listeners Surge

Pandora

Before the market open on Monday, Pandora (NYSE:P) released Audience Metrics for the month of December that significantly exceeded our expectations. Listener hours were 1.58 billion, up from 1.49 billion last month and 1.39 billion last year. For the quarter, listener hours totaled roughly 4.54 billion, above our estimate of 4.30 billion. Share of total U.S. radio listening was 8.60 percent, up from 8.44 percent last month and 7.58 percent last year. Active listeners were 76.2 million, up from 72.4 million last month and 67.1 million last year. Pandora’s positive momentum continued in December despite the launch of a free Shuffle service from Spotify for Android and iOS smartphones, and another month of competition from Apple’s (NASDAQ:AAPL) iTunes Radio, which launched in September. It is unclear what impact, if any, that inclement winter weather in much of the country had on Pandora listening, as it likely hurt on-the-go listening while helping in-home listening. Regardless, overall greater listener hours create a correspondingly greater opportunity to deliver advertising, likely driving Pandora revenues higher-than-expected.

We believe that stronger-than-expected December quarter listener hours position Pandora well to come in slightly above the high-end of its Q4:13 guidance. Our current estimates are for revenue of $201 million and EPS of $0.09, versus guidance of $196 — 200 million and $0.06 — 0.08, and consensus of $197 million and $0.07. It is important to note that Pandora’s cost per song is fixed through 2013, allowing the company to deliver operating leverage from any revenue growth. We note that Pandora shares have traded up significantly in early trading.

Also on Monday, Pandora announced that it will begin rolling out in-car advertising solutions this month in what it describes as a “first-to-market opportunity”. Users are able to listen to Pandora as part of the native environment of the car by leveraging a smartphone’s connectivity and the car’s in-dash entertainment system. We expect in-car advertising to be a significant long-term revenue growth opportunity for Pandora as, according to the company, nearly half of all radio listening occurs in the car. Pandora will offer fifteen- and thirty-second audio advertising spots across 130 vehicle models and over 270 aftermarket audio devices, with fewer audio ads delivered (at least initially) than on any other Pandora platform.

We are maintaining our FY:14 estimates until the scale and timing of the financial impact of in-car advertising becomes clearer. Although we believe in-car advertising presents a differentiating and compelling opportunity for the company and its advertising partners, we will be unable to properly model that impact until we learn additional financial details about the service.

Investment thesis

We are maintaining our NEUTRAL rating and 12-month price target of $33. Our price target is based on a $100 value per active user, reflecting Pandora’s accelerated growth from its shift to local ads and higher ad frequency. The company is finally beginning to show operating leverage through stronger control of content costs and SG&A spending, and is, we believe, positioned to deliver outsized earnings in the near future.

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.

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