Outlook: Are Pandora Listeners Tuning Out?

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Before the market open on Thursday, Pandora (NYSE:P) released Audience Metrics for the month of February that included weaker-than-expected listener hours. Listener hours were 1.51 billion, down sequentially from 1.58 billion last month, but up from 1.38 billion last year. The sequential decline in hours likely contributed to the early morning share price decline, as Pandora shares have been priced for near-perfect execution. We think that market share tells a more complete story, as shares of total U.S. radio listening was 8.91 percent, up from 8.57 percent last month and 8.25 percent last year, suggesting that the listener hour sequential decline was the result of seasonality for overall radio listening. Active listeners were 75.3 million, up from 73.4 million last month and 67.7 million last year. We expect listener hours to rebound over the next several months as in-car integration increases. We also expect revenue per thousand listener hours (RPMs) to trend up as improving measurement techniques increase Pandora’s appeal among advertisers.

Also on Thursday, Pandora stated that it will no longer disclose key audience metrics on a monthly basis after having done so for two years. This announcement may have accentuated investor concerns about listener hour softness, contributing to the sell-off. The final monthly release will be provided in June 2014 (for the May 2014 metrics), although quarterly disclosures will continue.

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 — including Triton Digital’s Webcast Metrics Local product (discussed below) — it no longer believes that there is a business reason to provide monthly metrics. More limited disclosure to investors, particularly after a sequential hours decline, may cause investors to be more skeptical about the story.

Although February listener hours were slightly disappointing, Pandora continues to show strength in the face of increasing competition. We do not expect competing services to seriously threaten Pandora until they can provide the kind of personalization that Pandora’s Music Genome Project provides to each of its listeners over time.

A recent win for Triton Digital should positively impact Pandora’s advertising revenue growth. Earlier this week, Triton announced that the Media Rating Council (MRC) had granted accreditation to its Webcast Metrics Local (WCML) product. We note that the MRC had previously provided accreditation to Triton’s national measurement product. The MRC is a non-profit industry association comprising TV, radio, print, and Internet companies, as well as advertisers, advertising agencies, and trade associations seeking to ensure valid, reliable, and effective measurement services. WCML provides traditional audio metrics to advertisers and agencies that enable the side-by-side comparison of terrestrial and digital listening. Accreditation at the local level should increase the appeal of advertising on the Pandora platform over the long-term.

Pandora once again showed signs of operating leverage in its business model in Q4:13. RPMs continued to grow at a faster rate than licensing per thousand listener hours (LPMs.) While RPMs are variable based upon ad numbers and pricing, LPMs are largely fixed with annual increases. We note that total RPMs increased by roughly 27 percent year-over-year, while LPMs increased by roughly 12 percent. The operating leverage is also apparent in content acquisition costs, which decreased to 47 percent of revenue in Q4:13 from 55 percent in the prior year.

Investment thesis

We are maintaining our NEUTRAL rating and our 12-month price target of $35. We value the company based on its present number of users. We assign a 15x multiple to our $7 operating profit per user per year estimate, and arrive at a value per user of $100. At $100 per user, 76.2 million users at year-end, and a share count of 218 million, we arrive at our $35 PT, which reflects continued user growth and improving monetization.

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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