Pandora: User Base Grows But No Profit In Sight

| About: Pandora Media (P)

On Wednesday evening, Pandora (NYSE:P) made its investors upset by announcing worse results than what they were looking for. The company's growth story continues but its operating expenses seem to grow at a faster rate than its revenues are and this will continue to worry the investors of Pandora for the foreseeable future.

For the full-year of 2013, Pandora's total revenue increased from $410 million to $638 million an increase of 55.58%. This indicates acceleration from 2012's revenue growth rate of 53.70%. Pandora has two types of revenues, advertisement and subscriptions. The company's advertisement revenue growth actually slowed down compared to 2012 but its subscription revenue growth more than made up for that. In 2013, Pandora's advertisement revenue grew from $360.72 million to $521.24 million, an increase of 44.50% against 2012's advertisement revenue growth of 54.68%. The company's subscription revenues jumped in 2013 from $49.29 million to $116.65 million, an increase of 136% compared to 2012's growth rate of 46.86%. The growth was fueled by the Pandora app usage increase in cars and Windows Phone 8. In Windows Phone 8, Microsoft pays for the advertisement-free subscription of the users.

Pandora's gross margin increased from 31.91% to 39.17% due to a slowdown in content acquisition costs. The company spent $342.88 million on content acquisition, up 38.09% from last year's $248.31 million and it was outpaced by the company's revenue growth of 55.58%. This year's content acquisition cost growth was not that bad compared to 2012's growth rate of 77.74%, which outpaced the company's revenue growth at the time, hurting the margins. Pandora's total cost of revenue rose by 38.99% to $388.01 million for the year of 2013. Meanwhile, Pandora's gross profit in 2013 jumped by 90%; it was up from $130.85 million to $249.89 million after an increase of 24.92% in 2012.

While in 2013 the company performed a lot better than in 2012 on the gross-margin front, its performance fell dramatically on the operating-margin front. For the full-year, all of Pandora's operating costs grew at a faster rate than its revenue growth. Pandora's product development costs jumped by 82.41% (up from $17.49 million to $31.91 million), sales and marketing costs jumped from $101.54 million to $182.92 million (an increase of 80.15%), and general and administrative costs jumped by 59.78% (up from $47.03 million to $75.14 million). All in all, Pandora's operating costs rose by 74.62% in 2013 against 2012's operating cost growth of 39.54% and the company's revenue growth of 55.58%. For the full-year, Pandora's operating expenses totaled $289.98 million, up from $166.06 million in 2012. This ate away all of the company's gross profit of $249.89 million and then some more. The company ended the year with an operating loss of $40.89 million, worse off than the previous year's loss of $35.21 million. When operating costs of a company grow at a faster rate than revenues, the company's operating margins fall. Pandora can't keep spending more money than it makes if it wants to stay competitive.

This year, Pandora's diluted share count rose from 167.57 million to 180.20 million, an increase of 7.54% after 2012's increase of 6.50% (the company's actual share count as of right now is 195 million and some change). Pandora is one of the companies that keeps growing its diluted share count, which makes it very important for the company to grow rapidly before the investors get upset about the ever-increasing dilution. While the company saw a revenue increase of 55% this year, the revenue increase was actually around 51% on per-share basis since the share count increased dramatically. By the end of 2014, Pandora expects to have a diluted share count of 225 million, which indicates an increase of 15.38%. On stock-based compensation, Pandora spent $7.93 million in 2011, $24.72 million in 2012 and $42.26 million in 2013. At this rate, this number will pass $100 million in a couple years.

During the year, Pandora's computer advertisement revenue increased by 10% as opposed to 2012's growth rate of 14% and the company's mobile advertisement revenue increased by 87% compared to 2012's growth rate of 103%. It looks like the company's advertisement revenue growth is declining at an alarming rate in both platforms and some caution is warranted, especially given that the company enjoys a very high valuation at the moment.

As of December, Pandora had 76.2 million active users, 1.58 billion listener hours (20.73 hours per listener), and a radio market share of 8.60%. The company's month-to-month user growth was 5.20% while month-to-month listener hours increased by 6.04%. Despite Apple's iTunes launch, Pandora continues to grow its user base and market share; however, the company has to make money someday (in fact, lots of it) in order to justify its current valuation.

In 2014, Pandora is expecting to generate between $870 million and $890 million and the company expects to report another year of loss after accounting stock-based compensation, amortization of intangible assets and tax expenses. Even excluding all these expenses, the company expects to earn about 13 to 17 cents per share, which values the company at 233 times forward earnings (excluding many cost items). Pandora will not be in a good spot if the market has a correction because high-flyers with ridiculous valuations are the first ones to fall in corrections.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.