Pandora Media's Management Presents at MKM Partners Investor Day Conference (Transcript)

Sep.26.13 | About: Pandora Media (P)

Pandora Media, Inc. (NYSE:P)

MKM Partners Investor Day Conference

September 26, 2013 10:00 am ET

Executives

Dominic Paschel - VP, Corporate Finance & IR

Analyst

Rob Sanderson - MKM Partners

Question-and-Answer Session

Rob Sanderson - MKM Partners

Good morning, everyone. So it's Dominic. Thank you very much for being here. It's Dominic Paschel from Pandora, VP, Corporate Finance and Investor Relations. Really appreciate you being here. As I said this to you before it's not often you get as much support being on the -- or with a negative rating as the excessive support that comes in the time that we put together I really appreciate it. I wish you see a lot more of this in Investor Relations kudos to you for that. I'm going to layoff a few questions and with the audience and just go back and forth. So I guess well let's start with the deal because you've been busy.

Dominic Paschel

Right.

Rob Sanderson - MKM Partners

This is right in your wheelhouse. So let's take the green shoe was exercise last week. What's the total expected net for Pandora? And let's talk about use of cash. You had enough flexibility I think in the balance sheet before, but now it's a whole new game for you in terms of financial flexibility, may be just talk about that?

Dominic Paschel

Right. So Rob is referring to the follow-on offering that we announced last week and executed on in a relatively shorter, with the bandwidth high and we're very excited to welcome some new kind of core tenant shoulders into the base. Kind of believe us in Pandora and kind of our mission of redefining radio in a connected world.

Net proceeds to Pandora should be around $380 million. We had an interesting supporter and deceived who has been with Pandora for nearly a decade. Crosslink Capital look to diversify some of their holdings. So in total I think they sold about 5.2 million shares. The company upside the deal from 10 million shares to 13 million shares. And so kind of, in terms of what we're doing with the money, there is nothing here marked plan that Pandora needs to go out and necessarily buy or change the game. We can go doing that from an organic perspective of developing a product like no other from Pandora's talented team. But ultimately we did feel somewhat undercapitalized for the business of our size, and we had nearly $70 million on the balance sheet, but last quarter we did $162 million quarter, where we grew revenues 58%.

So it's relatively undercapitalized. So we have a nice cushion and we have the ability to potentially make some acquisitions that would be tuck-in, and also we have more flexibility in terms of potential about how we work or deal with the content owners as well.

Rob Sanderson - MKM Partners

Mobile ad RPM. So you got a momentum here. I think this is absolutely that the key point to the story that you're scaling up on that and it's really a price leverage is really where the earnings power will eventually come into the model. So let's talk about the pathway to at $60 plus mobile ad RPM. How much of this can be non-audio? What are the mechanics to getting to levels of 16 and beyond?

Dominic Paschel

So, Rob is referencing our key metric, which is revenue per 1000 hours or RPM. And we also referenced from time-to-time our LPM, which is our licensing cost for 1000 hours. And so when you look at Pandora's business model, sometimes from far it looks like wow that it's hard to get that thing in harmony because if every more people listen, the more the cost rise.

First and foremost, Pandora is not a victim to our listeners. We are consciously allowing for that but we know that the business model -- the leverage and the business model isn't necessarily in the content side, on the LPM, that's relatively fixed, it does have annual increases but we know what that is. So the leverage in Pandora's model is really flexed through the revenue per 1000 hours metric. And so we have grown that overtime above our cost of content our LPM. So our blended cost of content is about $21 but our revenue per 1000 hours as a whole has been growing on our two kind of key monetization platforms, which would be known as desktop and mobile.

Desktop is now approximately 19% of Pandora's usage in terms of total hours. We're doing, monthly usage for Pandora is surpassed that of 1.3 billion hours a month, which is essentially what YouTube streams video in the U.S. And so as a function of having to pay that, we also want to grow the revenues to drive leverage in the model to reinvest in the business. And so RPM over the last year on our biggest platform mobile and other devices has grown from $23 to nearly $37 over that period of time. A lot of that has been the concerted efforts around our increase in numerator, which would be the revenue size. So continuing to drive revenue from our existing customers on the digital media interactive side, which is a $20 billion budget are a pool of money.

We're leading the charge on mobile as essentially a spot leader in terms of mobile ad products, mobile usage to the point we're one company in one country and we are essentially the third largest revenue generators for global mobile revenues. We're on about $0.5 billion run rate at this stage of the game. Last quarter, we grew mobile revenues 92% to $116 million. And so we're hoping to find that landscape.

And in the third bucket on terms of how we continue to grow the numerator in the RPM equation it's really about going after the traditional radio budget and pool of money and that's $15 billion pool of money. And by doing that that requires Pandora goes into the local markets. It's required us to gain tremendous scale, which we now have at roughly 7.5% of all radio. It required us to get measured frightened of that for Pandora and internet radio as a whole. It required that that measurement data be put through the system via buying platforms that radio buyers use known as STRATA and Mediaocean and kind of the four keys to the puzzle was to deploy the sales chain, which we're now investing and have invested in over 29 local markets. And so in concert, all three of those avenues of revenue ultimately drives the potential for not only total RPM to reach the level of desktop RPM but more specifically mobile RPM to reach the full potential of desktop.

Often times you got a debate about shifting dollars from desktop to mobile and that CPMs are less. That's true in the remnant market but it's not necessarily true when you think of Pandora's premium pricing on a direct basis. There is no difference in pricing when you look at our desktop versus our mobile inventory. The key difference is in the amount of inventory that we sell direct versus through indirect network and ultimately what will close the gap even further is by Pandora selling more and more of our inventory direct through these avenues.

Rob Sanderson - MKM Partners

Can you talk about the different deltas between the direct sales on mobile and the Remnant Network, what is the price goal at this point on the mobile side?

Dominic Paschel

Too. On Remnant?

Rob Sanderson - MKM Partners

No. Direct sales versus Remnant.

Dominic Paschel

Direct, okay. So direct sales of those more than 19% of our hours at this point on desktop. We essentially it's about kind of in the range of 70% to 75% direct and then the rest would fall to Remnant Networks of course. On mobile that has grown from the early time in the IPO would have been around 15%, it's growing. Now, we're doing orders of magnitude of 20% to 25% direct premium --

Rob Sanderson - MKM Partners

And the RPM difference?

Dominic Paschel

The RPM difference again can be dramatic. We don't audio inventory and video inventory doesn't fall -- never falls to Remnant Network. Anything that would interrupt the user experience we would always command a premium price point for it. Now, on the display component, display CPM is direct can be anywhere from between $5, $6, $7 premium direct versus kind of indirect channel that can be from $0.25 to about $0.50.

Rob Sanderson - MKM Partners

Right. Audio is the driver of the revenue on the mobile side today?

Dominic Paschel

That's right. Revenue is really being driven by the fastest growing part of the segment of the business is audio. Audio now composes of roughly 60% of our total revenue.

Rob Sanderson - MKM Partners

And I would think that's even higher than mobile?

Dominic Paschel

Yes, that is right.

Rob Sanderson - MKM Partners

Let's talk about the listing limits. It's one of the big; I think that was one of the big steps is actually of the first half of the year. Really pretty move, I think you got a lot of benefits from it but now its run its course and you feel like with this position where you can lift that restriction.

Dominic Paschel

Right.

Rob Sanderson - MKM Partners

So that's happened at the beginning of September. So I guess a couple of things, what do you think in terms of a rebound so far this month?

Dominic Paschel

So just to give some historical context, we in Pandora instituted a 40 hour listener run out to cap in 2009 on our desktop platform. We hadn't implemented on our mobile platform until March. On desktop the rationale there, we had RPMs that were at $18. Over the course of two years two months we were able to grow that RPM to north of $60. So we were able to govern the denominator part of the equation of RPMs here, revenue divided by total hours. That allowed us to grow, but grow in a way that we wouldn't hemorrhage cash as a prudent move we needed to do. We removed that cap as we reached our monetization goal on desktop and I'll come back to that in a second, around the point of indifference which matters on why we prefer the user to be as reported versus a subscriber from an economic standpoint.

Needless to say we did want to grow our mobile RPM as well at a faster rate to drive more gross margin dollars to reinvest in the business. And so in 2009 the cap impacted 10% of our user base. The one that we implemented in on mobile impacted roughly 4%, less that 4% of our user base. And we felt that that was the prudent move to make. So that way we could increase the investments on sales as well as R&D. I think our monetization goals there were met at a much faster pace that they were on desktop. So clearly we only had it in place for roughly seven months. But during that period of time as I said mobile RPM were up from $23 to now north of $37.

And then we also learnt some interesting takeaways when we implemented the cap on mobile device, which is that the less than 4% that we're hitting it were certain age group that were using Pandora's and on demand product. So they would skip through six songs to hit their max skip per station and then they change to another station. These younger demographic folks were looking to -- looking to use Pandora as an on demand product.

And ultimately that's not really the purpose for it. And I don't know my niece was one of them that hit the cap as she was skipping through her cache of stations looking for the new Katy Perry war song, didn’t find it there so she ended up skipping you know six more times on the Lady Gaga station and so that's not really what Pandora was intended for. It's more to be a radio in that environment.

So what we're able to do is we implemented in June the ability to control the 12 skips max per day essentially and we learned very rapidly that that controls the bigger issue of trying to kind of narrowing weed out the quality hours that were not being monitored on it.

Rob Sanderson - MKM Partners

Right. So that came in June.

Dominic Paschel

Right.

Rob Sanderson - MKM Partners

So you didn't really see as dramatic an impact on the audience metrics. So if you look on any competitor base, whether it be share, year-over-year, month over month. I mean year-over-year to normalize seasonality. Really the after those mid-March, sort of April/May was picked up sound in terms of growth and the June seemed -- didn't really seem to have the same kind of negative impact?

Dominic Paschel

I respectfully disagree. My phone bills for 48 hours would prove different. Every so often I'm on the expirer, I fire drill phone calls where I spend all day on the phone. And so when the June matrix release came out it did have an impact, it had an impact on the stock. People were like wondering if there was competition because everyone, because the prior seasonality. We see normal seasonality from May to June, there's sequentially decline as people go on holidays, school is let out. So last year I think our sequential decline from May to June was 4.4%. This year was 7%. And literally those 3 percentage points, 300 basis points kept me on the phone for 48 hours to qualify.

Rob Sanderson - MKM Partners

Can you say the base points are the impact of the skip limit?

Dominic Paschel

There was the additional impact. I would say the incremental/amplification of the hourly cap. So one thing to note though is our monetization did reach that point of indifference. We were still able to control the vast majority of the benefit of listener on our cap. So about 70% of listener on our cap is still being realized through the skip limitation. So when you look at hours going in September, October, November, clearly they're going to rise because we're starting to reach our seasonally strong period of the year, especially as we get to the fourth quarter. Holiday mean user consumption makes up 20 plus percent of our total hours. But you will see that rise. But you won't see it rebound the full kind of 10% suppression level because 70% of the effect is still being felt through the sort of comeback.

Rob Sanderson - MKM Partners

So it would come back to the third of what the full would have been. Is that a way to --?

Dominic Paschel

Well, I'm not here necessarily to give a midmonth update that release will come out in the first couple weeks of October.

Rob Sanderson - MKM Partners

Let's see. Any questions in the crowd. I'm going to keep going then. What are people most excited about Brian McAndrews first, big news, great hire credential wise but what's the buzz internal at Pandora?

Dominic Paschel

I personally have spent a good portion of the last week with Brian, got to know him pretty well. I think he just brings the quality and caliber of leadership that he's going to bring to Pandora and energy is perfect for the company and the cultural fit is from what I can tell is -- couldn't be better. His background, many know him from the street from because of selling. He is part of a first.com boom and bust, was able to grow a company and ultimately sell it to Microsoft to use, kind of been on the foundation of digital internet advertising. And so he also has background in terms of ABC, so he understands the content side, the media, the entertainment side and marries that with the technology side. So the company internally is just very, very excited to have his perspectives on how we can optimize the business.

Having been on the road with him, he has made it very clear that he is not here to fix anything, there is nothing broken here. And in fact, his number one goal is not to break anything. In terms of what his objectives will be, he is currently doing a strategic analysis of the company. You kind of have to give him a little bit more than five days on the job to give a strategic view. But he is coming up to speed at a very rapid pace. Just watching him throughout the Road Show from the beginning to the end, it's amazing just what he has taken and learns and the questions he asks.

And Joe Kennedy will be around our CEO and Chairman and Emeritus will be around for months to come, to help Brian come up to speed. Part of Brian, the opportunity to bring Brian on board though, going back to leadership style is, ever question has been asked in our business after a decade and answers have been given. So Brian will bring a new ability to perhaps -- quite the same questions can be asked but perhaps, new answers given.

Rob Sanderson - MKM Partners

There is comments earlier in the week from Tim related to Apple content, pricing and content cost. So would that same -- I think what Tim has said what that he believes that Apples content costs are similar but a little bit below what Pandora is saying today, so something to that effect?

Dominic Paschel

Yeah, he said in the ballpark I believe.

Rob Sanderson - MKM Partners

Something to that effect. I guess would that be true if and this might be a big assumption but if Apple were to actually be monetizing and they're not. But if they were monetizing they're paying a percent of their ad revenue, would that statement still be true if they were any reasonable level of monetization?

Dominic Paschel

We do believe so and for the fact of the matter. I mean, there's a great article that recommends if you're really curious, intellectually curious on the subject this book by Rockonomics, just go to rockonomics.com and search Pandora, search Apple and it actually walks through one of the independent label deals, which I mean you have to also make an assumption, do those near that of big three, where Pandora is not here necessarily to say yes or no. But as you walk through the Rockonomics article, it talks about the puts and takes associated with the skips associated with the incremental value for per match et cetera. And so that would imply a rate that it is in the ballpark of where Pandora is paying if not less.

If you factor in the monetization engine side and which surprised me if one of Tim Cook's strategic initiatives would be to deploy a 1000 person old school media radio sales team, when in fact he hasn't even shown any kind of affinity for the digital side, internet advertising. So why does Vanguard new thought leader kind of company going back to old school radio just blew my mind. But now where I can see them is where they've demonstrated this to some of their major advertisers, they've signed up, which is kind of what Pandora did six, seven years ago where somebody would come and buyout a very low CPM with sponsorship. So ironically guess who the first one, ever that did Pandora was.

Rob Sanderson - MKM Partners

Was it Apple?

Dominic Paschel

Yes. It was Apple, kind of very low CPM at that point. But that's what you do as you start out in this business. And so the way they could look to monetize would be through IAD, which are the indirect or performance channels that as I just mentioned, describe our sell-through concept. The whole point is to get away from that because of the low CPM value. So if you think that 15% of a very low CPM is going to move the needle a lot we'll see how the map plays out, my guess is it doesn't.

Rob Sanderson - MKM Partners

How significant are the volume of skips? In the whole equation for Pandora I mean before the limit.

Dominic Paschel

Well I mean you can kind of do back-on-the-envelope math where if 10% of net hours were being suppressed due to the limit or due to the listener hour cap and that 70% of that's going to be still maintained. You can kind of estimate what the skips would have been.

Rob Sanderson - MKM Partners

So 7% is a reasonable ballpark?

Dominic Paschel

Yes, yes. At least from 7% of the time. So we do listen to hour time, yeah.

Rob Sanderson - MKM Partners

That is the matrix that you report in your audience, right?

Dominic Paschel

That is right. So we use, Pandora listener hours, so if you skip four times with an estimate just each song is for three minutes but you listen to a temporal hour with a music that would be essentially in a Pandora hour that would be an hour and 12 minutes.

Rob Sanderson - MKM Partners

Any -- last chance of question from the audience. Real quick one then your technology spend. I know this is an area that you consciously been focused on bringing up --

Dominic Paschel

Right.

Rob Sanderson - MKM Partners

And is the bigger investments that you've been making in, on the monetization side or the user experience side? And are there other large areas of tech spend that are focused here?

Dominic Paschel

Sure. We've been -- I mean our percent of revenue, our R&D for investment has been somewhere in the range of 3% to 4%. We've upped that -- consciously tried to get that to around the 7%, steady state operating model. Those investments are taking place in all areas of the product. Tom Steam has divided the growth and retention teams. How do we engage users who have left or who are inactive? How do we get more hours per user? What type of products are we embedded in and we want to be everywhere. That's the key tenant of radio, ultimately the user experience.

I would say a good chunk of R&D goes into the area you don't see, which is not the UI, which is not the kind of a bright shiny object. It's literally what makes Pandora better than any other radio service out there, which are the algorithms right. There's been a lot of talk around Apple and kind of what it means for Pandora. I think we have said in recent appearances that the reason people come to Pandora is because they can hear it anywhere and everywhere, not in a closed ecosystem. If you look, if statistic we gave out on Tuesday was that half of all IOS users in Pandora over the last 12 months used their Pandora login on a non-IOS device meaning, you have to be available everywhere.

Well, what makes Pandora special is the algorithm to know that at a given period of time, when you're searching for we are young by fund, this was 36 months ago; it might be a SoHo New York Hipster searching that out. They are going to have a certain type of expectation of where that bonsai tree or that algorithm takes them fast-forward to the first time you hear we are young on Super Bowl commercial. Different set of expectations for the user that is going to search for we are young by fund.

And then, finally, fast-forward may be six months after that when it was covered on Glee, you're going to have like a Gleek, he was looking for it and different set of expectations. And those algorithms have to be maintained, so the algorithms are dynamic, they are reflective of culture, they are reflective of age, even location in terms of how we give you the next best song you are going to hear or we think you are going to want to hear. And there has been a lot of need to products out there, I think Apple is the last and final entrant that I know of that would have had radio as a feature and that's the challenge, as a lot of people who have radio as a feature use it as an on ramp to get new as a consumer to do something else, to buy more music or to become a subscriber of Spotify or what have you. For Pandora radio isn't non-ramp, it is the freeware.

Rob Sanderson - MKM Partners

We're out of time. But thank you very much Dominic.

Dominic Paschel

Yeah. Thanks Rob. I appreciate it.

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