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Pandora Media, Inc. (NYSE:P)

BMO Technology, Media & Entertainment Conference Call

December 11, 2013 9:00 AM ET


Dominic Paschel - Vice President, Investor Relations


Edward Williams - BMO Capital Markets

Edward Williams - BMO Capital Markets

I’m Edward Williams, the Digital Entertainment and eCommerce analyst. So thank you all for coming this morning. With me I have Dominic Paschel who is with Pandora and will give us an update on Pandora. I think you want to begin with…

Dominic Paschel

Yes, we just have a quick message from our Founder, Tim Westergren on kind of the passion and mission of Pandora. So we’ll go ahead and play that for you right now.

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Dominic Paschel

Great. Well, thank you Edward for having us here and that is the core and passion of Pandora. Our singular focus is to redefine radio for a connective world, and we are now doing that on a very large scale and order of magnitude where we now have more than 200 million registered users within the United States. We have more than 73 million active users that listen on average 20 hours a month to Pandora.

Often times we are asked what do you want to achieve? What is your goal? How many do you want, a100 million users, you want 200 million users? Untimely, our ultimate goal would be to be the world’s radio, and we are working and progressing towards that. In the U.S., we would like to essentially allow for 93% of the U.S. population that still listen to the radio on a weekly basis to listen to Pandora. On average, the U.S. consumer listens 56 hours to radio, so we still have some ways to go to achieve that goal.

Our goal is to combine the best of radio, which is free ad supported to the consumer, zero work, ubiquity, and discovery, combine that with the best of the internet, the one to one component, the personalization, the interactiveness that the internet provides.

This is the first time that this medium of media really is right for disruption from the likes of the Internet. If you look at every other form of media, it has gone through some form of disruption. The reason radio is perhaps one of the last forms is because only today is Internet connectivity becoming as pervasive as radio waves and arguably in some places where you wouldn’t otherwise hear the radio.

For example, 35,000 feet up on a Virgin America flight, you don’t hear it or perhaps going under the Bay in San Francisco on BART where we have Internet connectivity. All of those reasons allow for Pandora to achieve and fulfill the dream of being the next generation of radio.

Question-and-Answer Session

Edward Williams - BMO Capital Markets

As we think about that, there is still topics I wanted to get into, but given what you are getting at now and the amount of hours that people are listening to Pandora in a monthly basis, and if we look at the amount of hours that people listen to radio overall, there is a significant amount of listening that occurs in cars, and so if we look at the auto market, what is your role at this stage in those cars and what’s the opportunity that you see on a going forward basis?

Dominic Paschel

Yes, auto is an amazing opportunity for Pandora, one that is barely begun to be fully tapped or even just scratched the surface of rather.

Pandora, three years ago, when I joined the company before we went public, Pandora was embedded into three cars at the time. I went to my first consumer electronics show and it was in the Mercedes S Class, the Ford Escape and the Mini Cooper, that’s it. Within basically 2.5 years, Pandora is now in more than 100 different models and that statistics is even stale. We’ll be updating that coming January.

Last week was the LA Auto Show that I was able to attend. It’s amazing where you see Pandora integration with the type, the style, etcetera, and so when you look at our success there, it’s just starting. 47% of radio is consumed in your car, so the 56 hours a month, nearly half of that is consumed in an auto. Pandora has nearly two – has and again the statistic is of May, but 2.5 million unique activations within the car.

Stage one of our auto integrations really were by lean-forward users, so they would plug in their Smartphone or Bluetooth to it, but they’d control it from their Smartphone. A phase two is really taking place right now with the Native App integrations and the Infotainment systems. So often times there are – each car automaker has their own name for it. In Toyota, could be the Entune; Cadillac, it would be the CUE System, in BMW, it is BMW Apps, but you still need your Smartphone.

For those worried about kind of the amount of consumption, it’s very, very light on your data plan. We stream with proprietary technology that it is very interesting, because often times we get a lot of emails from users about varying topics, need a pass code. One frequent one is, can you help my wireless carrier not drop my call, because you do great things with Pandora, and so we stream at 32 kilobits per second, you would require 70 hours of Pandora consumption fully on your Smartphone to go to 1 gig, so data plans are not an issue.

Phase three of the auto implementations will start to roll out likely in the 2015 models. General Motors indicated at Mobile World Congress last March that the day for your car becoming one of your devices, like your tablets is not far away, and so we want to continue to reduce the friction related to auto implementations, and auto makers are using Pandora to sell their cars, and so we have a short video that you are likely seeing here now on commercials that are hitting timely with the holidays. This is from Honda.

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So Honda was, obviously safety with rearview camera and fun with Pandora. They were one of the later implementers of Pandora, but they were also one of the more aggressive ones, so they are now implementing it fleet wide to become the first automaker to do that. So it’s exciting they are using Pandora. Now it’s a competitive disadvantage if you don’t have Pandora in your vehicle.

Edward Williams - BMO Capital Markets

Thanks. I’m glad that Michael Bolton made an appearance at this conference. I’ve hosted this conference for a number of years, and I think I’m now.

Dominic Paschel

Musical talent.

Edward Williams - BMO Capital Markets

Its now complete for me. Anyway so there are a couple of other hot topics I’m going to get into, and just to remind the audience that we have an app, if you do want to submit a question, feel free to do so, and I’ll see it up here and can ask it.

But lets look at the competitive landscape. There’s been a lot of noise of late about Spotify offering a free version on their mobile app for it, so can you just elaborate and obviously in September with Apple with iRadio product, can you just give us an update as to kind of how the competitive landscape has evolved and what your perspective is on it?

Dominic Paschel

Yes, for those of you who I speak with frequently, you noticed this is a bit of a groundhog topic for me, Groundhog Day topic. When we look at – just to remind those who may not be as familiar with Pandora, we have to talk about the way, the consumption of music takes place, it’s bifurcating. I mean it has been for decades.

Before though it was easier because you could physically differentiate between the media types, the physical differentiations; you had radio and you had got vinyl records. You had radio 8tracks in the 70s, radio cassette tapes in the 80s, radio CDs in the 90s until the advent of Napster and the digitization of music.

Then, at least the perception was that all of a sudden, music was competitive in every format. The reality is the U.S. consumers behavior still very much is the same, which is 80% of their time with music is spent in a lean back environment, that’s why 90% of the population still listen to radio on a weekly basis.

The other 20% of that on-demand world, those are served by numerous providers. Often most of those numerous providers actually have a radio feature, and that is exactly that, it’s a feature. It’s meant to be an off ramp to get you to go to another venue to get you to a different purpose. You have to buy music on iTunes or to perhaps become a subscriber of a service, and that’s generally what we see from that constituency.

For Pandora, our core passion and goal has always been about perfection of your personalized radio like experience, and so what you’re seeing in particular with the announcements from Spotify, the media reports last week and perhaps their media event today is more a reflection on them, its not a reflection on Pandora.

Ultimately that business model is one that has unique challenges in the sense of gaining scale. It is also one where their core is to get, to convert users to becoming paid subscribers, so as subscription conversion falls, you have to cap other turning points and ballasts to try to refill the subscriber funnel.

When you look at some of what is rumored, you know it’s very similar, the way they launched in Europe, which is you have limited number of lifetime plays of a given song, and that again is to compel you as a user to become a paying subscriber. And so, where Pandora believes the true opportunity to be is really kind of on the two of the kind of hallmarks of radio, which is free app support to the consumer and zero work, and that is the cycle that – it’s a self fulfilling cycle where you need one and that creates the other and so on.

And so, in order for that to happen anytime, you have to create a playlist anytime you have to do the work. Even if you share a playlist from a friend at some point, the serendipity of that playlist becomes boring, and so ultimately that’s where the consumers behavior falls back to radio.

Edward Williams - BMO Capital Markets

And if we were to look at the international opportunities for a moment, so you guys have been very successful in the U.S. market, and you’ve expanded into Australia and New Zealand about a year and a half ago, can you give us a sense as to what your thoughts are and what could be next? Where we are in Australia and New Zealand first of all, but then secondly looking at the audience here, I see a number of people who have come down from Canada. When will they get to experience the joy of Pandora on a day-to-day basis?

Dominic Paschel

Bank of Montreal right. Yes, I mean so lets start with how we view international expansion as a whole. We are patiently opportunistic in the sense of we will enter into a geography when it makes financial sense, so we are patiently optimistic in the sense that unlike the U.S. where we pay a per track per play basis, our philosophy on international expansion is we could arguably enter into a number of geographies by doing that today. Unfortunately, it takes a decade to scale to that business and you lose a lot of money.

The convention for radio is that there are royalties that are paid. We are fine with paying royalties, we are fine and believe actually that the artist deserves and should be paid. Unfortunately, you cannot scale a business without tremendous time and effort and money when you pay on a per track per play basis, which is actually an odd ball when you look at kind of the global radio standard. It’s usually somewhere in the mid-single digit percentage of revenue.

So in Australia and New Zealand, we launched officially almost one year to the date. We are now in the Australian auto markers’ cars. The Holden is rolling out with Pandora in the vehicle. As our story is waking up, their Thursday, starting soon, there will be a big media report locally out in Australia which talks and speaks to the fact that we now have reached million subscribers in Australia and New Zealand, which is our first kind of disclosure around it.

We are also beginning to monetize, so I believe CNET got a hold of one of Tim’s emails to our users saying we had to pay on a per track we had to pay for the content, so we need to monetize, we have that responsibility, so the way we license in Australia and New Zealand is very similar to the way it is in the U.S., a similar type of compulsory license where you have the two bodies. So to remind those, in the U.S. we pay, the vast majority of our content cost goes to sound exchange on a per track per play basis, which about half goes to the artist, half goes to the label.

And then we pay publishing fees for the lyrical rights, and that goes to the PROs, the Performance Rights Organizations like ASCAP, SESAC, BMI, and that’s a single digit percent of revenue. So in Australia and New Zealand, we have similar bodies, APRA AMCO, CPNZ and PPAU. So when we look potentially to go into Canada, most likely it would be through similar compulsory structures. The challenge is that there is no timetable, and unfortunately we’ll announce it after actually we’re there, but we’re patiently optimistic about our international opportunities.

Edward Williams - BMO Capital Markets

Going down just a little bit, can you give us some color to the approximate percentage of revenues that we should look for content cost out of Australia, New Zealand relative to..

Dominic Paschel

Yes, it’s not a secret or limited to what we put in our SEC filing back in July of last year, but the terminology was less that 25% of revenue for the region.

Edward Williams - BMO Capital Markets

And if you look at content cost on an overall basis, they have been coming down as your getting your monetization up, but we are coming, we’re a little bit away from the renewal, but we are getting closer to the renewal. Can you give us an update as to kind of what to look for over the course of next year or two years?

Dominic Paschel

I’m glad you noticed that content cost was coming down, because I know people often ask when they look at the business model where is the leverage. Well as we grow our RPMs faster or as we monetize rather faster than listener hours, our RPMs growth and that translates into gross margin.

That gross margin has been growing, which now cost of content has been reduced to 48% of revenue. That’s down from 52% the quarter before and 56% the year before that. So we are doing good things on the monetization side as we scale and become a very large provider of mobile inventory and translated into the third largest global mobile revenue generator, now in the $0.5 billion run rate.

Content cost, the way it looks, obviously in our target model we had it at about 40% of revenue. As the way we’ve monetized desktop, we’re head of that, which would drive content cost down from 40% to more in the range of 33%, 34% of revenues. So we’re ahead of that on desktop.

On mobile as we have our RPM that mirrors an average of around 50, effective across the board in mobile and desktop, we converge upon the 40% cost of content line. So looking at the Copyright Royalty Board proceedings which kicks off in January this year, it’s a two year federal process that takes place, very similar to what Sirius XM went through and ultimately their rates for a five year period were set a year ago this month, so a little bit off cycle from Sirius.

The same Copyright Royalty Board, except they will have a new member I believe coming this year, and so it shouldn’t be viewed as a fearful process. Its one that has played out greater than in many, many decades worth of copyright law and so its one where you get to engage in. This will be Pandora’s first COD proceeding. The difference between what will be known as, this one which is Webcaster IV versus Webcaster I and II is that they are actually market rate benchmarks now internet radio, which the challenge with the prior ones were that they weren’t.

Edward Williams - BMO Capital Markets

Then within monetization, so where are you at this point with regards to having local sales and in how many markets are you in, to see your headcount for sales. What’s the ROI on adding those sales guys and what should we expect in terms of investment on a going forward basis.

Dominic Paschel

Right. So Pandora pools from three very different pools of money; two of which are somewhat adjacent. That would be the mobile and negligible media interactive. So the $427 million we did last year, all of that came from the Internet mostly and mobile.

Mobile is massively growing. It’s going to be $7.7 billion this year. If you look at eMarket it was up from the $3.5 billion last year at any estimates. I don’t know what yours are Edward, but still growing $12 billion, $15 billion. It’s a massive opportunity and we’re meeting the front there. Second, really only that Facebook is a pure play app vendor on mobile devices.

When you look at the third bucket, which when we think of local we think of radio. So this is slightly different from kind of hyper local group on within social and even somewhat different from like your model. It’s really about regional spenders that spend upward of $1 million plus annually.

Think of your traditional radio. Like in New York here you might hear Sleepy's ads or in California you might hear Fry's ad and we’re really going after that when we think of local. We’re in 29 markets, 29 of the top 50 markets. We have roughly 80 people that come from the radio industry, that have started to go after that massive opportunity. Its $15 billion and its one that is very unique only to Pandora.

Pandora is the only player of this scale and magnitude that has legitimate access to your auditory abilities and so its why ultimately we believe it to be our near term objective just to have that market. If we can align our market share which is 8.4, an all time high of 8.4 with our wallet share, which is probably sub 1.5% of that, I mean that alone could add an additional $1.3 billion to Pandora’s revenue.

Edward Williams - BMO Capital Markets

All right, what’s the willingness of those local advertisers to move on to Pandora? What’s holding them back from shifting more of their spend.

Dominic Paschel

Yes, its kind of like the build outage that you didn’t get fired for hiring IBM. So there is some conditioning. I mean the nice things about these local radio advertisers, once you get them – Sleepy's has been advertising on V100 or what have you for a decade or longer. Shane Co. in California, God its been on the local radio for 30 years I’ve been told and so that’s the nice thing, but its literally they kind of dip their foot, test it, see the ROI.

The beauty of Pandora versus broadcast radio is its like moving in from kind of the Flintstones into the Jetsons era right. You have attribution, you have a targeting, you have measurement, you have recording in a way that broadcast ratings kind of counted how many people came into your dealership, versus how many people installed your app. Its fascinating and somewhat surprising that its taking this long to really change the way radio has been operating.

We are integrating in the STRATA and Mediaocean now, so from a buying standpoint we may have reduced the friction and so that was a critical step. We have measurement from Triton who has been a very valued partner of ours. They are presenting I think right after us in the room next door, but Triton has been huge in terms of seeing where the future of radio is headed, whereas other players have been stuck in the past.

Triton has been able to help Pandora roll out now I think in 275 different markets, understanding what our market share is in those markets and it helps us act, sound and talk exactly like radio, so the data that Triton would give out is AQH cume rating, cume score, all of that. So that way radio buyers were reducing any possible friction that they would have. And so really the only good piece that’s left is inertia and getting people to allocate 10,000, 20,000 and these buys do get bigger the more experience they have with us.

Edward Williams - BMO Capital Markets

At this stage lets just shift gears for a little bit. First of all, see if there’s any questions in the audience? One upfront here.

Unidentified Participant

One, when will Nielsen and Arbitron have the ratings out for you guys and the second one is how long is the sales process for the local markets right now?

Dominic Paschel

So only really Nielsen understands kind of the timing component there. I would say that its not of an issue. Triton is very valued and respected in the marketplace. That’s going to be – you kind of have to look at their public statements from the acquisition. They’ve indicated certain timing components that may or may not happen, but at this point one of the reasons why we didn’t wait for Arbitron is because we did have Triton, again a valued and respected partner that in the marketplace there is no issue with kind of – there aren’t big issues with kind of the acceptance of that sales cycles.

The reason that we needed the Triton data integrated into STRATA and Mediaocean is for that reason, for the hyper local, which is the top four billion of the 15 billion. That transacts in rapid speed. So an auto dealer might be going on a Thursday and realized, shoot, we have X units still in our lot. We needed one Y number of ads and so with Pandora to transact that it shouldn’t but it did take upwards of three days and that’s not acceptable and you can do rapid transactions on a one off basis, but you cannot scale that when your running thousands of campaigns. So the sales cycle definitely had less visibility, but the pricing there is also materially higher, because you’re able to transact that quickly.

Edward Williams - BMO Capital Markets

Are there any plans to make inventory accessible programmatically through DSPs?

Dominic Paschel

There’s been some speculation of that in some of the notes that I’ve seen. We’re not ready to really announce any product initiatives, ad initiatives around that. I would say that we have definitely unique capabilities and backgrounds to do that.

We have a very talented guy who came from Google that if you look at some CNET articles he talks about some of the programmatic views and real-time bidding components that we can enter into. We definitely look to optimize our ruminant inventory. We were selling more of our inventory direct, hence why we get the RTM uplift.

Fundamentally when we sell direct we get the best price points. But of the perhaps smaller ruminant and getting smaller ruminant portion, we are looking at ways on how to optimize that core of the business through our RTB potentially and programmatic and I think I would say stay tuned on that.

Edward Williams - BMO Capital Markets

All right, well shifting gears, next month we have CES. Hopefully we’ll see many of you that are present there, we’re hosting out there, but anyway (inaudible) is becoming more and more pervasive and Pandora is widely available on many, many different places. Can you give us a sense as to how much of the usage is occurring if you will (inaudible)?

Dominic Paschel

Yes, for as much time as we spend on mobile, its kind of a topic de jure. My guess is in two years or less the whole thing is going to be, what are the exciting things that your doing on the Smart TV or what are you doing on – I mean Pandora is embedded in now a Jacuzzi I found out three months ago. I don’t have one, but I found out about it.

Its saunas you know where – I mean the vast majority of the usage on the saunas devices is Pandora or again the cars. You know those are all exciting opportunities for us and Pandora’s already on the forefront of that leadership. We’re in a thousand different consumer electronic devices as of last year at CES.

This January will be exciting. I’m sure we’ll have various updates to give on January, the week of January 6, but one thing that was – I mean when you look at the potential, the ad potential of some of these products, I mean imagine having a 15 five inch, HTML5 television that actually has some unique ad capabilities that otherwise wouldn’t, and again once we’ve seen our consistent theme, cMakers are using Pandora to play, purchase, sell their devices and so one last clip we have for you is one that will be hitting around CES time. It gives you a bit of a chuckle too.

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Dominic Paschel

So its awesome to be within a company and application that has this broad appeal and that’s our goal to becoming as ubiquitous as radios, to be in every aspect of your life, anywhere you could have music and that’s the true kind of magnitude this offers.

Edward Williams - BMO Capital Markets

Thank you very much.

Dominic Paschel

Thanks everyone.

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