Shares of Pandora Media (NYSE:P) closed up 1.5% to $25.03 Tuesday on a day after suffering a 2% decline due to a downgrade by analysts at Susquehanna (NASDAQ:SUSQ). Although the analysts maintained a positive outlook on the company, they lowered their targets by 27%, from $41 to $30.
On Tuesday, the shares changed course after Mike Herring, the company's CFO, affirmed his belief that despite constant threats from Apple (NASDAQ:AAPL) and Google (GOOG, GOOGL), the internet radio giant plans to widen its lead in a $50 billion ad-supported radio industry, in which it has close to an 80% market share.
That's all well and good. But after a decade in existence, Pandora still has not shown investors that it can make any money. Even with its 80% share, the company has been riddled with deteriorating profits. So what's the point?
To its credit, the company has done the impossible. Management has worked hard to survive the arrival of Spotify, iHeartRadio and a host of other Internet rivals. Not to mention Sirius XM (NASDAQ:SIRI), with whom Pandora is often compared.
In an odd fashion, revenue has steadily risen, despite a noticeable deceleration in active users. The number of people that sign on to the service each month also increased, by almost 30% to 75.3 million, which is just shy of analysts' year-end target of 76.2 million. Pandora should have no problem meeting/exceeding that number. This also means that the company's market share of the U.S. radio listening audience now surpasses 9%, which is impressive growth.
Admittedly, I haven't been Pandora's biggest supporter. But there is no way to spin this performance without giving the company its due credit. This means that the company is doing a decent job in squeezing pennies out of its listening hours.
But unlike Sirius' subscriber-based model, making money has not been one of Pandora's strengths. This is despite such solid growth and meaningful market share. While Sirius generates a strong level of cash flow, Pandora has posted a year-over-year decline in net income in the recent quarter, dropping from -$28.59 million to -$28.93 million.
It's bad enough that Pandora was already in the red in terms of profits, but this performance placed Pandora in the lower tier of companies within the internet software/services industry. When Pandora released its most-recent monthly metric, the numbers show that the company is growing in popularity. But that's also part of the problem.
Pandora's popularity is and has always been a double-edged sword. The more people that listen to the service, the more it costs the company to operate its business. Since Pandora doesn't own its music content, it has to pay a royalty to the owners of the songs.
Essentially, the more music you listen to, the higher Pandora's fees become. To-date, the company has not shown that it can effectively monetize this business model. At least not to the extent where these royalty/content costs can become more manageable.
It's not all bad news, however. When compared to Sirius XM, Pandora has a significantly higher gross profit margin of 38.29%, which is impressive. The company has increased this metric significantly on a year-over-year basis. But Sirius is the only one making any money. Despite Pandora's margin advantage, it posts a negative 15% net profit margin.
Remarkably, this is even with the fact that Pandora has roughly 3 times the active listeners of Sirius XM. To that end, I don't believe Sirius XM is sinking at all. Its main challenge is finding another revenue source beyond the auto. Pandora's main challenge is developing a business model that makes money. And after more than a decade in existence, it's time for management to stop repeating this song. Until then, the better play will remain Sirius XM.
Disclosure: I am long AAPL.
Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.