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Pandora Media (NYSE:P)

February 13, 2013 1:20 pm ET

Executives

Joseph J. Kennedy - Chairman, Chief Executive Officer and President

Analysts

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Great. So we'll go ahead and get started. We're really excited to have with us Joe Kennedy, the CEO of Pandora.

Question-and-Answer Session

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Joe, for people on the audience that may not be as familiar with Pandora beyond just it being the services they listened to on their iPhone, how do you describe the company now?

Joseph J. Kennedy

I would say Pandora is defining what radio is in an Internet-connected world. We've all grown up with radio, I think many people are surprised, there's still -- just in this country alone, 240 million people listen to AM/FM radio still every week, and listen, on average, for over 50 hours. There's a tremendous opportunity to disrupt that with a dramatically better consumer experience using the Internet and personalization, in particular, and there's a opportunity to disrupt the advertising side of that with dramatically more effective and efficient advertising for radio advertisers.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

What's more important for you at this point as CEO of Pandora, growing usage or monetization?

Joseph J. Kennedy

If I look back on our history, certainly when you start an ad-supported media business, you have to -- there's no question what the chicken and egg is in the ad-supported world, it's a scale business you have to grow audience. Now that we've reached the scale that we have, I think over time, it's much more a balance consideration of audience growth and revenue growth, monetization growth, and I think that's really where we are at this point, given the scale that we've achieved.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Got you. How much of that, when you think about growing revenue and growing monetization, what are the levers that you're looking at, is it all salespeople?

Joseph J. Kennedy

Really, I think, at a high level, again, almost 80% of our usage is not on the traditional desktop/laptop browser computer experience, so it's really about mobile and other connected devices. And really, the 2 main strategies we've been prosecuting for some time and having very good results with are taking all of those digital advertisers that we've come to know and work with over the last 7 years, and really see a great strategic partner for them as they expand from desktop-centric advertising to embracing mobile, and we think we brought a lot of great ads products and insights for them to help them become a multi-platform advertiser, that's strategy one. And strategy two, is that opportunities to disrupt the traditional radio advertising business, still a $15 billion business. Those are the 2 strategies that drive us. Underneath those strategies, there's different tactics that are important in terms of driving those, but those are really the key at a high level.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

So you mentioned the traditional radio market, it's something I know you guys have talked a lot about before, but maybe it's worth touching on here. When you look at the economics of where Pandora is now relative to that traditional market, where is Pandora?

Joseph J. Kennedy

I think we are just in the earliest stages of the opportunity to penetrate and disrupt the traditional market for radio advertising. Just the beginning of the first inning. The great majority of our revenues have come from the digital side even in the most recently reported quarter. So we're very excited as we bring together the share that we now have with radio listening, north of 8%, as you look to the staff, the salespeople, able to build those connections both globally and nationally in the radio ad sales market. And the systems, the measurement of our audience and the steam we've had of make Pandora as easy to buy as your traditional AM/FM radio station or radio network. And really, we see this year as the convergence of those 3 things, the share and the staff and the systems as really enabling us to accelerate our penetration of the radio ad sales market.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

You mentioned systems. Towards the end of last year, you actually got integrated with some of the more traditional radio ad-buying systems, what's that allowed advertisers to do with Pandora that they couldn't before? What kind of impact have you seen?

Joseph J. Kennedy

Yes, I wish I could show you what a screen shot looks like. And these are not automated buying systems some people get, these are the workflow tools that the people who buy radio advertising use every day sitting at their desk. And when they look to place a buy, they used to have a set of radio stations for a given market, and they'd see the size and the audience of those radio stations, whether it's KFOG or you name it, if it's the Bay Area. Well, now on that same screen is the -- is Pandora, WPAN, if you will, and the size of Pandora's audience side-by-side with those radio stations. So there's really 2 key things that the integration in these systems will do for us is: one, it makes it immediately evident in comparable terms the size of the Pandora audience opportunity that we can bring to an advertiser; and second, it makes Pandora as easy to buy as those FM stations. In terms of just the mechanics, the time and the effort to buy Pandora becomes the same as buying a traditional radio station or radio network, and those are 2 key things. We still need salespeople to take each client and each media buyer across the rubicon, so it's not just -- there's some instantaneous step function. But it is a fundamental enabler for our further entry into the radio ad markets.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

As Pandora moves more into the automobile, how relevant is satellite radio as a business model comparison?

Joseph J. Kennedy

I think the satellite guys -- it's a subscription business and it's very auto-focused. I think, our belief is there's really 2 different pieces to the Sirius XM value proposition for consumers. There is the music radio side, and I think we do that better than they do that. And therefore, in some sense represent a threat to them, particularly as we are increasingly present in cars. But they've also invested enormously in brand names, spoken word content, news, sports, talk, you name it. And that's not a category that we've chosen to play in at this point and probably is a more distinctive part of the value proposition. And for those consumers who really are wrapped around some part of that spoken word content, then there's probably less impact, at least, as we've articulated our strategy at this point.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

So as you build down the local sales force sort of market-by-market, can you update us on where that rollout is now?

Joseph J. Kennedy

Sure. If -- last year, the local sales force, and this is really focused on the radio opportunity in each of these local markets. Last year was really about the top 10 markets, and establishing our footprint there and beginning to get some traction there. This year, we're expanding. The top 25-plus markets have been doing a lot of hiring, consistent with what we've indicated that we would do, so there's no news there. And so really positioning ourselves to broaden that footprint in terms of the number of markets that we're in, and excited to go after more and more opportunity there. If you think about it, as our share continues to grow, the amount of revenue opportunity in each local market only increases. And so perpetually, markets are becoming increasingly attractive to us. And again, in combination with the systems that we have, it presents us with a very good economic opportunity. I should also mention again that the advertisers in these local markets were not going after the local restaurant, the local spa, the people who've traditionally bought local radio advertising -- the San Francisco Bay Area Toyota Dealer Group, Fry's, big retail chains -- they're pretty big advertisers. And so this is not a "send an army of people out there to knock on every sole proprietorship," these are reasonably large, medium-sized businesses in local markets, and it's fairly efficient for us to go after those markets with the sales force that we've developed.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

And is that size of advertiser what makes using sort of feet-on-the-street sales force more effective for Pandora versus the Internet model of self-serve?

Joseph J. Kennedy

Right. I think someday there may well be a role for self-serve. I don't think there's a one or the other. I think to be in the Internet advertising business in today's world means perpetually identifying opportunities to use technology to make the buy more efficient and effective for the advertiser and to make it more efficient for us in terms of delivery. And so we continue to do that, even the workflow system integrations that I talked about, I think, are pretty good example of that. But these players who come in with budgets -- there's global advertisers we're working with who are 6-digit advertisers with us on Pandora, and it's a strategic relationship. There's a role for people in terms of getting that client the first time and making sure that we're serving that client well and getting the maximum amount of budget that we can for that client in the economics of having some degree of human involvement in that just makes plain sense.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

You mentioned the technology side of it, Pandora uses billions of different inputs to determine what song gets played next. What role does that kind of data and that kind of technology play in the advertising side of it?

Joseph J. Kennedy

Yes, I think from the beginning, because we're a registration-based service, that's been a tremendous advantage for us. We have the e-mail address and the birth year, gender and zip code of every user that we have, and we've used all of those as targeting variables as well as the music We've begun to bring more and more data science for them in terms of developing heuristics. For example, we've developed heuristics to, with high confidence, identify Hispanic listeners, we don't have explicit identification if a listener is Hispanic. But we can look at all of the range and information that we have and maybe a very high probability assessment that this listener is part of the Hispanic audience and bring that to advertisers who are targeting Hispanic listeners. And I think, again, that falls in the category of there's a lot that technology and data can bring to advertising in today's world, and there's certainly more opportunity for us to combine those 3 for the benefit of our advertisers and for our benefit, too.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

How much of a role does that -- does location, particularly with mobile devices, have the potential to play in terms of targeting advertising? We, yesterday, hosted an advertising technology panel and a mobile ad panel, and everyone was talking about geosensing and that type of thing. Does Pandora see an opportunity in going to that level of targeting overtime?

Joseph J. Kennedy

Yes, I think -- I spent most of my career as an advertiser. I think I bought $1 billion-plus of advertising. I think there's 2 pieces to it. I think in terms of the amount of the $150 billion-plus ad dollars that are spent in this country. I don't think a particularly huge part of that is affected by legal time geo-targeting of that advertising. But I think -- I'm not saying it's insignificant, but in the grand scheme of the total spend, I don't think it's -- the majority of advertising is going to become real-time, geo-targeted. I think some of the most interesting work that's going on with some of the tech players is actually using the geoinformation more for what we talked about just a minute ago in terms of just deepening their understanding of the consumer, and I think that's important. In our case, because we have zip code, a vast majority of advertisers who want to advertise with some degree of geosense find that very valuable. They're targeting a DMA, the San Francisco DMA, or a range of DMAs, and the zip code information we have for each registered user have been highly effective for them. And I don't think would be particularly enhanced by real-time geo, as opposed to the zip code information that we have.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Now, it makes sense. When you look at the content cost side of the equation, you have sort of a very regulated, structured setup that a lot of your competitors sort of don't benefit from. How do you think about content costs longer-term, particularly given some of the legislative activity that Pandora's involved in?

Joseph J. Kennedy

Yes, I think on the issue of content cost, again, 2 things are true that I think is really important to understand. On the one hand, we believe that the content cost that we pay currently, particularly on what we pay to performing arts and labels, is simply unfairly high, it's out of line with any standard that's ever existed for radio in this country today, other forms of radio in history around the world, et cetera, and we'll work to try and get our content cost to a more fair level of compensation for artists and labels. At the same time, we are so good at monetizing what we do and on the path to continue the improvements in that monetization, then we can build and make a good business consistent with the target operating model that we shared at this time with the IPO, with content cost at or near where they are. We said at the time in the IPO, we think we can get content cost to 40% of revenue in the context of an overall model that delivers 20% operating product -- operating profit. We continue to believe that we can deliver that with content cost at or where they are, as we get the leverage of improved monetization per hour -- enabling us to get some improvement in the percentage of our revenue that's taken up by content cost. So again, those 2 things are true, the costs are unfairly high, but we can meet the top -- the operating model and build a good business with rates where they are.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

How are you thinking about sort of the legislative outcome?

Joseph J. Kennedy

Yes, I think we had good success over the last 6 months in terms of getting the key policy makers, key Congress persons in Washington, interested in this issue even already this year the chair of the House Judiciary Committee, Bob Goodlatte, has said he wants to hold more hearings on the issue of music and royalties. I think the policymakers inside the halls of Congress see the fundamental problem of different royalty structures based on different delivery technologies and how just inappropriate that is. And so, we look forward to them diving into that issue. Of course, passing legislation is always hard, and at the start of the process, you always have to say, "It's more likely nothing will pass than something." But I think we're excited that the key policymakers see the problem, want to dive in the issue, and we'll continue to support their efforts to find solutions. That makes sense for us and makes sense over the long term for performing artists and labels and all of their constituents as well.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

How do you think about the competitive environment around music right now, not just online radio, but even just more broadly?

Joseph J. Kennedy

We've now been on the market for a 7.5 years, and I think there's been -- there's a lot of players who come and have innovative ideas and bring things to the market. And I think that's a great and it's vibrant. I think we focused on this opportunity to define the future of radio, really taking advantage of the personalization potential that the Internet presents. And instead, we're not focused on this competitor or that competitor, we're focused on being the absolute best in the world at delivering a personalized radio experience. And everyone in the company understands that job one is to not only maintain our leadership, but that we believe we are the best in the world in that, but to expand that leadership. And that's ultimately the protection that we have and why our share of all Internet radio listening only continues to grow, and importantly, our share of total radio listening is -- in this country continues to grow, despite the various efforts of competitors in Internet radio and outside of Internet radio.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Great. We do have a large audience, I want to open up things for questions. As we get the mics up. While the mics are coming up, maybe if you could just take a couple of minutes and update us on where you are in Australia and New Zealand, and what International potentially represents for you?

Joseph J. Kennedy

Well, we're very excited. We just -- we were in a beta mode in Australia from July through early December. And then we lit up everything in mid-December. The iPhone became accessible; Android, we actually just launched on Sonos down there. So the full Pandora distribution footprint is opening up in Australia. Very exciting to us. Too early to talk about specific results, but really very excited from our standpoint. And I think you want to read all the press down there, good reception in terms of people see Pandora as a clear differentiated powerful addition to the digital music landscape down there. In terms of International, generally, I think we continue to be in a mode that I've described in the past as patiently opportunistic. We’re not going to enter markets where the royalty structure isn't conducive to the creation of long-term value. The good news is, we've got an economic structure in Australia and New Zealand that does make sense, we're very excited to grow that market. But we're not going to enter other markets, until we have the right kind of economic structure. We certainly -- the good news is we have 8% of radio listening in the U.S. and that's a hell of an achievement over the past 7 years. But that also means we have enormous, enormous, enormous opportunity to grow in this country, and so we don't -- we're not desperate for growth on the international side. But we continue to work on that there. Look forward to making Australia and New Zealand a great example for us and for rights holders and for consumers and everyone in the ecosystem. And hopefully, that will enable us to switch to the opportunistic mode, which is when we see those opportunities and the economics makes sense, we'll move pretty quickly.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Great. Morris [ph]?

Unknown Analyst

I have 2 simple questions. When you listen to terrestrial radio and you compare it to Pandora, the obvious difference is, you're inundated with advertising, you just keep changing the channel because you can't take it. When you plan your business, particularly as you become more mobile in cars, what's your target in terms of how many minutes of advertising and the length of each advertisement for each 30 minutes that you drive? Because at a certain point, Sirius gets better because you don't have to listen to anything. That's question one. Question two is a question on personalization. One of the great things -- if you're listening at home, listening to Pandora, you get the Like button, and it gets better and better. But if you're driving in your car, there is no Like button when you're going 60 on the expressway. So how do you personalize that? Is there going to be sort of a voice recognition, "I like this one, I don't like that one" you could get question?

Joseph J. Kennedy

Sure. Maybe I'll take it in reverse order. Actually, the various implementations of Pandora in cars do include the thumbs up and thumbs down functionality, different automakers and their suppliers have done it different ways. In Ford SYNC, you can press the sync button and literally say, thumbs up. And using voice controls, you get to thumb up. In other cases, one of the standard buttons on the radio tuner interface, if you will, when Pandora is playing, say in a Cadillac or in a Honda or in a Toyota, is the touch screen, hit the thumbs up, hit the thumbs down. And so that personalization potential is there. And we cared fanatically, as do our automotive partners, about safety and driver distraction. And the general school of thought there is, you don't want the consumer to take their eyes off the road for an interaction more than 1 second or 2 seconds. And traditional radio has always had that find the button to change the station, and find the button to give a thumbs up fits into that well-established pattern of interactions that are proven safe in a vehicle, so I think we're in a good shape there. To your first question, yes, the ad load on traditional radio is crushing, the standard model in AM/FM radio today is 13 minutes of advertising an hour. The typical consumer on Pandora today is probably much closer to a minute. We have focused on 15- and 30-second ad units, that's the ad units that we are offer. Traditional radios does a lot of 60-second ads. There is actually a paradox in the traditional model, that the more you bury people with advertising, the more advertisers want to take 60 seconds to try and do something goofy to grab your attention. And so it's a downward spiral really in that model. The great thing is our ads are so much more powerful for radio advertisers because they're targetable, because they're interactive, because they're measurable. That we believe we can achieve the monetization required for our target model in a way that leaves us with far less ad load than the additional model and serves advertisers much better, and obviously, serves consumers and our economics very well. So that ad load -- 3 years ago, we had essentially no audio advertising on Pandora. We very gradually raised that over the last few years. So the typical consumer today probably gets between 1.5 and 2 ads per hour. We'll continually -- continue to very gradually raise that ad load and find where that proper equilibrium is with the consumer. But I'm confident it will be at a level that's much lower than where traditional radio is. In the end, gives us this great opportunity that it's a win for the consumer, it's a win for the advertisers and it's a win for Pandora and Pandora's economics.

Unknown Analyst

Joe, 2 questions. One, we all know that the content cost issues and concerns have impacted the profitability of the model. One thing I forget is the history of content cost. When did content cost for you guys fall out of line? Or has it just been you had an expectation that over time they would improve? If you could just go over the history of that a little bit, that would be very, very helpful. Also second question is, what's the consumer value proposition today of Pandora versus Spotify? Just want to understand that as Spotify has evolved.

Joseph J. Kennedy

Sure. And I think I'll start with the second one. In terms of the value proposition of Pandora versus Spotify -- and Spotify's in the same world as Rdio and Rhapsody, et cetera. We've grown up side-by-side with the so-called on-demand services. Against Rhapsody is in many ways the granddaddy of those and is still around today. And the key value proposition that went on on-demand services that you can listen on-demand to a track of music that you want. So if you've got to hear Mr. Jones by Counting Crows and you've got to hear it right now, you can do that in Spotify, Rhapsody, Rdio, et cetera. In a certain sense, it's the modern digital equivalent of going to the record store and having the album. You're leasing the music store instead of buying it album by album, but that's part of the consumer experience. At Pandora, we focused on being the Internet world definition of radio. So that place you go when you don't know exactly what you want to hear, you don’t want to think about it, you're busy doing other things perhaps. You say play me some music like Counting Crows, and we'll play some Counting Crows and some other great bands and music in that category. And throughout the history of consumer consumption of music entertainment, that latter category, the radio, the serendipitous experience, has been 80% of consumer time spent with music entertainment. There's Veronis Suhler Stevenson study that showed this for decades. And so we've really focused on that part, being absolutely the best in the world at that. There has always been a companion to the radio experience of the record store experience, and Spotify and others are attempting to define that in the Internet world, and that's the key difference from a value proposition standpoint. In terms of the history of content cost, this can get pretty deep and pretty arcane pretty quickly. I think the headlines are up until 1995, no form of radio paid any royalties to performing artists and labels at all. In 1995, Congress passed an act called the Digital Performance Rights Act, and satellite radio and radio over cable television were, for the first time, required to pay royalties to performing artist and labels. In 1998, as part of the DMCA, that so-called performance right was extended to Internet radio. And for the first time, Internet radio had the responsibility to pay a royalty for performing artists and labels. Over the course of the subsequent 10 years, the royalty -- I'd say, the royalty through 2005, was set at a level that's about half of what we pay today. There was a royalty tribunal that took place in 2007 that many people believe was just off the tracks. It would have tripled the rates that Internet radio had to play. It resulted in congressional intervention, 2 different acts of Congress were passed in response to that royalty tribunal failure. And that laid the foundation for the compromise royalties framework, under which we operate today. We said when that compromise was reached, it actually took 2 years to reach that compromise in 2009. We said at the time, "Hey, this is a compromise framework that we can go forward with and build a business with, but it's still fundamentally unfair, and we're going to circle back and try and fix the fundamental foundation for Internet radio royalty rate settings." In an essence, that brings us to today, where we've operated under this compromise. As we said, we can build the business under it, hit the target operating profit model that we've articulated. But it's still, there's a foundation that's fundamentally unfair relative to Internet radio and we're circling back to Congress, very consistent with what we've said for years, and said, "There's work to be done here." And the core problem stems from, even as I told you this brief history, the laws were passed one at a time in response to specific technological developments in radio. And so we now have a patchwork of radio-related legislation, where broadcast radio pays nothing to performing artists and labels. There's this '95 law that governs satellite and cable radio, the '98 law for Internet radio, it's different from the '95 law, and so you have this patchwork. And again, I think the people who really care about good policy in Congress see the fundamental problem of tying radio to its delivery technology and want to circle back and figure out a way to rationalize that entire structure, and we're very supportive of those efforts.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

We have time for one last on the call [ph].

Unknown Analyst

Just a quick one. Is there anything the U.S. can learn from the way the content costs are structured in Australia or New Zealand? And how do those content costs compare to what we see in the U.S.?

Joseph J. Kennedy

Yes, I think the specifics of our content agreement in Australia and New Zealand are subject to confidentiality. We have pursued them with that agreement, there's a specific set of language that we have the right to inform investors with. And there was an 8-K filing at the time of those deals that says -- I'll do my best to quote it, "That we anticipate that content costs in Australia and New Zealand for both performing artists and for songwriters will be less than 25% of revenue." And that -- I think what that's demonstrated is, there's a structure there that's conducive to the development of the business. We have a good economic incentive to get into that market, fully develop that business, and I think it's going to be a win for the rights holders as well as for Australian consumers and for Pandora. We have said explicitly -- this is knowledge throughout the rights holder community, "We will not enter any international market on the basis of a per track played royalty structure." It's fundamentally antithetical to the proper development of the radio opportunity. And there's absolutely no history in radio royalties of per song played royalty compensation. And so, I do think that the model under which we operate in Australia and New Zealand is much more -- it's actually much more in line with the history of radio compensation of songwriters and performing artists, and I think it lays the foundation for the development of Internet radio around the world in such a way that I think it would truly be with a win for all of the parties, including the song holders, the songwriters, performing artists, the rights holders and, importantly, the consumers as well as for entrepreneurs who are developing these businesses.

Heath P. Terry - Goldman Sachs Group Inc., Research Division

Great, Joe. Really appreciate you taking the time to join us today.

Joseph J. Kennedy

Thank you.

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Source: Pandora Media, Inc. Presents at Goldman Sachs Technology & Internet Conference 2013, Feb-13-2013 10:20 AM
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