Pandora (P) is the leading provider of internet radio in the United States and is well positioned to gain additional market of online display, mobile and radio ad markets. An investment in Pandora is a pure play on the rapid adoption of mobile internet connected devices and the mobile advertising revenue that comes with the territory. Pandora is well positioned to continue its momentum and take share from traditional radio as users migrate toward the greater flexibility and personalization of Pandora's Internet offering, while advertisers are attracted to the better targeting.
Revenue growth has been accelerating
The company has seen revenues accelerate for three consecutive quarters. The company saw a 51% year over year growth in the third quarter of this year, 60% growth year over year in the fourth quarter 2013 and 55% year over year growth in the first quarter 2014. The initial reacceleration in the third and fourth quarter was driven by increased marketing efforts around the product and the ability to upgrade to Pandora One on iTunes and Google Play.
The first quarter 2014 saw the company impose a listener hour cap which forced heavy listeners to either lower their usage or sign-up for Pandora One at a monthly recurring cost. The conversion of users from free to paid was much higher than management initially forecast and caught investors off guard. Total net additions for Pandora One totaled 700,000 new users, a figure higher than all net additions in the entire fiscal 2013 year.
The all important mobile ads
It seems that mobile advertisement concerns are prevalent at any company that offers services on smartphones and other connected devices. Pandora is no exception and has been under scrutiny as far back as 2011. As mobile listener hours approach 80% of total listener hours, investors need to be assured that the company is properly monetizing on this trend.
Pandora reached an important point in the third quarter 2013 when growth in mobile advertising revenue surpassed mobile listener hour growth for the first time. Mobile advertising RPMs (revenue per 1,000 listener hours), which have typically been about one third the level of desktop RPMs, are approaching one half the level of desktop RPMs. Advertisers are gaining a better familiarity with mobile ad buying and the company's growing sales force will continue the gap at an accelerating pace. The importance of mobile advertising can be summed up by company CEO Joseph Kennedy: "Because mobile is well suited for local advertising, this segment of our business is growing quickly."
By 2015, Pandora will be the third largest recipient of mobile ad revenue trailing only the industry leaders Google (GOOG) and Facebook (FB). A study places the total value of the mobile ad market to be $7.1 billion in 2015 and $32 billion in 2017, a drastic increase from $2.4 billion in 2012.
The all important numbers
Pandora recently released its August listenership hours of 1.35 billion, up 16% year over year, and 5.5% month over month. August is typically a rebound month from a slow summer but this month's listenership was significantly stronger (5.5% versus last year's 3.6%), ahead of the removal of the 40 hour limit.
These numbers indicate a positive trend as Pandora's services continue to grow despite new entrants and with recent improvements in monetization helps the company overcome its content costs and improve valuation of the company.
Competition? What competition?
Pandora has received negative attention in the past year as countless rumors have surfaced regarding a much larger player entering the field like Apple (AAPL). The company's iTunes Radio was dubbed by some as a "Pandora killer" but initially failed to "wow" the public when the product was initially showcased.
As we stand today, the iTunes Radio is far from a threat to Pandora according to many experts. The largest drawback of iTunes Radio is the need to be a part of the Apple ecosystem as it is not available on other platforms and devices. Pandora is available on more than 900 consumer electronic devices, including integration in autos where approximately half of all US radio listening takes place. Pandora services will come pre-installed in roughly one third of all new vehicles sold in 2013 with this number increasing over time. This essentially creates no upper limit on the addressable market for Pandora, while Apple's limits is pre-defined by the number of users in their ecosystem. Investors who were hoping that Apple can just enter and take over the market should carefully reconsider such an investment thesis.
Pandora has a leg up on any competitor in terms of members (70 million+ active users) and holding a first mover advantage since beginning operations in 2005. Pandora has consistently held its 80% share of the total market with the second biggest player, Clear Channel Online, which represents anywhere from 5-10% share of the market.
I believe that Pandora listeners will remain mostly loyal to Pandora and won't migrate over to a competing service. The very action of listeners "investing" in their stations (by giving thumbs up/downs, skipping songs, etc.) creates stickiness and a loyal connection. It is incumbent on iRadio to provide a compelling reason to abandon Pandora and try iRadio, which at this point appears to be a "me too" product.
Pandora has dealt with competition in the past which has not negatively impacted its share of the market. Spotify, Google, Clear Channel's iHeartRadio, Slacker and Sirius XM (SIRI) all tried to compete with Pandora with little impact.
Speaking of Sirius XM
In the context of this article, it is impossible to not mention Sirius XM Radio, the leader in satellite radio services in the U.S and Canada. Until recently, Sirius XM enjoyed an almost competition-free environment, with the only competition coming from local radio stations. With Pandora's expansion into cars, investors need to ask the question is Sirius XM in trouble?
Right now, Sirius XM is the much bigger company (market cap of $23.06 billion compared to Pandora's $3.35 billion) and holds a key advantage in the auto radio market by already fine tuning the ability of its satellites to deliver a strong signal and high audio quality. Sirius XM also holds exclusive agreements that Pandora will never be able to match such as NHL, NFL, PGA and MLB coverage as well as programming from Howard Stern and Oprah Winfrey (Oprah Radio).
Sirius XM is also investing in other verticals including a premium telematics services similar to OnStar. Finally, the company has already repurchased over 200 million shares so far and has returned nearly $1 billion to shareholders since the end of December 2012 through stock buybacks and a special dividend. The company intentions to pursue over $2 billion in buybacks, and management noted that they are on track to complete the promise to shareholders.
Pandora is one of the top Internet names in terms of audience reach, trailing only Facebook and Google in monthly consumer usage. The company's music genome algorithm is unlike what any other media company has to offer and will continue attracting new subscribers (and advertisers) for years to come as the market continues to grow over the coming years.
Like Facebook, the company has figured out very quickly how to monetize mobile usage, which effectively eliminates one of the largest bear cases against owning shares of the company.