Seeking Alpha
Long only, research analyst, portfolio strategy, media
Profile| Send Message|
( followers)  

Pandora (NYSE:P) has a problem most content streaming companies have, and that is how it can differentiate and defend itself as it operates in an increasingly competitive marketplace.

Before we get into some issues, it has to be understood that yes, it isn't hard to understand Pandora from a strategic point of view. Almost always when people challenge the sustainability issue for streaming or other Internet companies, they almost always say something like "you just don't get it." What is meant by that is it's assumed it isn't understood that the reason the company isn't making money is because it's using capital to scale the business. Yes I get it.

Having said that, this isn't the issue for Pandora in my opinion. Rather it's the inability to see how it is going to defend its business in light of the growing number of new competitors into the marketplace.

(click to enlarge) source: StockCharts

Netflix

Netflix (NASDAQ:NFLX) is a good case study concerning the particular vulnerability Pandora faces. In the case of the video streamer, Netflix had the same strategy of scaling the business, and understood that once it reached a certain level it would have to differentiate in order to defend itself from market erosion.

After all, streaming is only a delivery system, it's not a moat a company can rely on. Now the first to take a big lead can make some money over the short term, but over the long haul a company must add something to make it stand out to those spending their money for the service.

This is why Netflix started to spend big money on original content, and is experimenting with "binge" releases. A binge release simply means the entirely of the series for that season is released all at once, rather than incrementally.

If you want to know why Netflix is probably overpaying for content, it's because if it doesn't differentiate and build a defensible moat, it would have to compete on price, and that's a game no company wants to play.

(click to enlarge) source: StockCharts

Sirius XM Holdings

It's interesting to see Pandora's competitive landscape going the opposite direction Sirius XM Holdings (NASDAQ:SIRI) has in the past. There is really no satellite competitor Sirius has to deal with, and so it can focus on competition from those attempting to reach the auto market via a streaming business model.

For Pandora, it's being hit hard with new competitors, and there are more of them emerging. There will be a plethora of competitors before the streaming radio market starts to consolidate, which will take years. Of course I have no doubt some of these competitors are being built for the sole purpose of being acquired by a larger company.

Sirius also competes in a similar manner Netflix is moving towards; building out its unique, original content offerings. This is why the company has been able to grow over the last couple of years.

The point is streaming companies must differentiate. If they don't, there is no way they will be able to defend themselves.

For Sirius the challenge is its being tied to the health of the auto industry and its vulnerability to an economic downturn, where potential customers start to cut spending.

Pandora is starting to ramp up its move towards in-vehicle competition against FM and Sirius, but I don't see that as being a big growth engine; although any additional listeners is a plus for the company.

(click to enlarge) source: StockCharts

Pandora's Competition and Strategy

As mentioned earlier, Pandora is implementing the usual strategy of scaling the company. It appears in the United States that it is reaching its upper limits on active users, and so will have to use capital to expand to international markets.

In the meantime, it will have to make a decision on whether or not it should focus on further monetizing its customers in the U.S. while it grows overseas.

Since streaming is something that can be scaled fairly quickly by anyone with some capital behind them, Pandora is in a difficult place because it already is being challenged domestically, and is already being forced to defend itself on more than one front.

Apple's (NASDAQ:AAPL) iTunes Radio is the biggest concern domestically for Pandora, as it quickly added about 20 million listeners. Some of those were taken from Pandora, although it is being spun as those that were only casual Pandora listeners.

(click to enlarge) source: StockCharts

The media made it appear as if Pandora had successfully resisted the Apple onslaught, but that is really premature, as the battle there has really only just begun.

One positive thing for Pandora is Apple has lost some of its luster and swagger, and it isn't the scary company it was to competitors that it was several years ago. Nonetheless, quickly grabbing 20 million customers isn't something that can be ignored or neglected. Only time will tell if it was the Apple core customer base that gravitated to iTunes Radio, or if was something more than that.

A couple of advantages Apple has is in the size of its song catalog, which include over 26 million songs. Pandora on the other hand has over 1 million songs. The other competitive advantage is Apple is offering its subscription service for $24.99 a year. Pandora charges $36 per year. This has no effect on ad-supported radio.

For now this may not be a problem, but when the next recession hits people will immediately look for ways to cut costs, and at that time Pandora may be pressured to lower its subscription price.

The biggest concern with Apple iRadio is if it does become profitable, other big companies would definitely take a serious look at starting up a similar service. Here again we have the moat issue.

Other current competitors include Spotify and Clear Channel's iHeartRadio.

Conclusion

There are several things Pandora must do to defend itself and grow in the increasingly competitive radio streaming marketplace.

First, it has to defend its U.S. market position, which it now has about an 8 percent market share in. It may be reaching the limit on its current most active users, so it should focus on taking steps to boost the listening time of their core customers.

Next, it will have to target international growth as domestic competition heats up. It has a presence in Australia and New Zealand, and should expand in those markets. Since it hasn't even entered Canada, Western Europe, UK or South America, it leaves a lot of places it could successfully move into.

Having said all of this, the major question is still that of a moat, and there isn't one at this time for Pandora. If the company decides to aggressively pursue international growth, it could overcome potential slowing of its domestic business.

I think Pandora will have to spend to develop original content in order to have a profitable, long-term future. Even if it grows and continues to increase its mobile ads, the reason for it is because of the ears it has listening. How it will retain and grow the number of listeners is totally unclear. Unique content is the only answer I see that will bring about sustainable growth.

Even if Pandora scales itself around the world, it still has the most important question to face, and that is a sustainable business model. To achieve it Pandora will have to spend capital; whether it's via international expansion, increasing the listening time of its most active users, or building a moat that is difficult to compete against.

Watching capital allocation in the months ahead should give a signal as to what Pandora is going to do. Absence an original content strategy, I don't see how anyone can accurately project the future of Pandora, as it will eventually be forced to compete on price, and that means the company with the biggest pockets will win. Pandora isn't that company.

Source: Pandora's Vulnerability And Major Challenge