Pandora (NYSE:P) recently went public and after a successful IPO is trading at just above the $16 price tag it went public with. Pandora is among the first Internet radio companies to go public, and understanding that Internet radio is a new dynamic may have investors a bit confused over what metrics are the important ones to watch.
Let's face it. When a company has a quarterly conference call it tends to highlight the positives and find reasons to explain away the negatives. While the financial performance is an obvious target, the important numbers can sometimes be lost in the fog of discussion about potential.
When invested in Pandora, some key element that investors will want to watch go much deeper than revenue and cost of revenue. Investors need to dig deeper, and perhaps more importantly they need to know where to dig.
Metrics that Pandora Investors will want to watch:
An obvious choice for obvious reasons. What investors want to look at is the total revenue, the revenue from advertising, and the revenue from the subscription side of the service. The importance here is understanding the dynamics of where Pandora gets its revenue. What investors want to see is growth in the advertising line, which supports the "free" version of Pandora, and the growth in the subscription revenue, which supports the Pandora one subscription tier.
Currently this is the bread and butter of Pandora. Listeners are exposed to advertising, which generates revenue for the company. Pandora gets advertising dollars in a couple of ways, audio ads, and visual ads. This puts the company in direct competition with other Internet radio providers as well as terrestrial radio and even satellite radio - Sirius XM's (SIRI) non-music channels have ads. This is a crowded field, and many various companies are vying for budget space in the advertiser's portfolio. Pandora, with nearly 35 million active users, and more than 90 million registered users, carries a lot of weight. Continued growth is dependent on the company being successful in designing ad campaigns that fill both the audio and visual advertising needs of the market.
If you are invested in Pandora you will want to see growth in this category quarter after quarter. The company saw massive growth with the advent of the smartphone. That growth is still happening and Pandora should continue to make innovative advertising deals such as the recent announcement of a long term deal with Toyota (TM).
This category accounted for about 14.5% of Pandora's revenue in the most recent SEC filing outlining the IPO. The company generates revenue here from people subscribing to the premium tier of the service in lieu of listening to or viewing advertising. Revenue from this category should see growth each quarter as well, but not as quickly as the advertising side of the business. One important reason to watch subscriber revenue closely is that if Pandora elects to raise prices or institute a royalty fee, there could be a huge influx of premium tier subscribers. Another reason to watch this category closely is that the royalty rates are higher on the consumers that subscribe.
MARKETING AND SALES
Pandora spends a good deal of money on marketing and getting the service included in electronic devices, or even into the dashboards of cars. Investors will want to watch this line item and ensure that the costs here are not becoming a bigger percentage of the revenue line.
This is the perhaps the most important metric to watch. It is in this line item that Pandora accounts for all of the money it spends on royalties. In the IPO filing the company reported that nearly 60% of the revenue went directly to paying for content. One big drag on Pandora is that the royalties eat up a substantial part of the revenue the company is able to bring in. There is a way that Pandora can limit the royalty payment, however. The deal with record labels calls for a per listener per song rate OR 25% of revenue, whichever is greater. If the company can boost revenue high enough so it can change the entire dynamic of this line item. Investors need to pay close attention here.
In theory this company wants more people listening more often. The problem here is that the more people listen, the more the company pays in royalties. It is a catch-22 that has most that look at the Pandora business model scratching their heads. How can the company effectively grow if when they do so the costs increase substantially? This goes back to the possibilities that exist in getting to royalties equating to 25% of revenue. Increased listener hours is a double edged sword. Investors need to be aware of this. A good way to gage this is to compare the percent increase in listener hours to the increases we see in revenue as well as content acquisition.
Pandora oft boasts that it has more than 90 million "registered users." This metric is not really that important. The important metric is "Active Users." Active users are people who have engaged the service with the last 30 trailing 30 days to the end of a reporting period. Think of it this way, active users are those who are using the service now, in the current quarter. Advertisers will want to know the active users, not the over-inflated number of "registered users." Currently the company has between 34 million and 35 million active users. Growth in this category is the measure of how successful Pandora is at resonating with consumers.
AVERAGE REVENUE PER ACTIVE USER
While not an official metric, this is an effective way to gage growth and success. It is a simple calculation of dividing the revenue by the number of active users. At the time of their IPO Padora's ARPU per Active User was about $0.50 per month ($51,040,000 / 34,000,000 active users / 3 months). What investors want to see is this metric growing quarter after quarter.
ACTIVE USER ACQUISITION COST
At this point we do not have any data to really go on. This metric will not likely be reported by the company, but can be a valuable tool in measuring the success or lack of same. In order to calculate this investors can add the "product development" and the "marketing and sales" metrics and divide by the number of new active users reported by the company. The key here is getting an understanding of how much money it will cost Pandora to gain a new active user, and then how long it will take Pandora to recoup the investment by comparing it to ARPU.
This is yet another metric that investors will not likely see the company offer up on the quarterly calls. I define this as the success of the company in getting registered users to become active users. In the IPO filing the company stated that it had 94 million registered users and 34 million active users. This would translate into a 36.17% conversion rate. That gives us a decent starting point. What you want to see is that the company is capitalizing on the registered users by getting these consumers to engage the service. Registered users carry potential value. Making them active users makes revenue.
The bottom line is that some of the best ways to measure the successes of a company are not found in the quarterly reports and SEC filings. Investors need to not only compare the company with itself each quarter, but also the peers of any given company. I would venture to say that most that invest in Pandora are betting on potential. The company indeed has potential, but also warrants close monitoring by investors.
Disclosure: Long SIRI