In the ever evolving world of audio entertainment, the business model of Pandora (NYSE:P) has oft come under attack as a model that cannot sustain itself. The chief complaint is that the more people that listen to Pandora, the more expense the company has. This mantra is a gross generalization typically employed by people who dislike Pandora because it is a competitive force in audio entertainment. The fact is that every business on the planet sees costs rise as more people use their product.
Long ago I made the statement that Pandora was closer to recording a profit than many people realize. In their most recent quarter that is exactly what they did, edging out a very slight profit of $638,000. While not impressive when compared to a more established company like Sirius XM Satellite Radio (NASDAQ:SIRI), the road to a profitable quarter when many thought it could not be done is a feat in and of itself. Pandora is still a risky play, but the fact that the company has now demonstrated that they can and will produce profits sets a foundation for the Street that did not exist up until now.
So how did Pandora do it? While year over year numbers are often used for comparisons, I like to look at how the company is progressing much closer to the here and now. This is where quarter over quarter comparisons come into play and paint a picture that lets investors gauge metrics a bit better in some cases.
Revenue jumped from about $67 million last quarter to $75 this quarter - an improvement of 12%. Compared to Sirius XM's 2.5% improvement for quarter over quarter results this is quite impressive.
Content acquisition went from $33.7 million to $37.7 million. This represents a 12% increase. You will notice that the increase in content cost on a percentage basis is less than the increase in revenue. This is a good thing for Pandora. Despite the mantra that Pandora spends more when they gain more listeners or when those listeners listen more, the company was actually successful in making their revenue outpace their content costs.
Pandora now boasts 40 million active users. In the most recent quarter their average revenue per user (ARPU) $0.625 per month. Last quarter the company had 37 million active users. Their ARPU then was $0.60. The most recent quarter delivered an addition 4% in ARPU, a good move.
ARPU is a metric familiar to many Sirius XM investors, and while sixty cents seems to pale in comparison to Sirius XM's $11.66, there are some things to consider. Sirius XM added just over 100,000 subscribers per month last quarter. Pandora delivered new active users to the tune of 1 million per month. This brings up the old adage about volume. Simply stated, Pandora is bringing on more users by a factor of 10! Yes each user brings in less revenue than Sirius XM, but the company is showing growth that can and will be more impressive as time passes.
Pandora is also gaining traction in listener hours. Active users increased by 9% while listening increased by 17%. Numbers like these will be impressive for advertisers, which is how Pandora garners the bulk of their revenue. Advertising revenue jumped from $58 million last quarter to $66 million in the most recent, an impressive 14% jump in one quarter.
One thing to note here is that the business model is far from being mature. Advertising is going in a good direction for Pandora and they are gaining traction very quickly here. If Pandora can increase advertising revenues by another 14% next quarter, they could be setting up for another surprise for the street.
If things are looking promising for Pandora, why is the equity being punished? The answer is that the business model is still developing and the costs associated with a modest profit in Q3 make it hard for investors to swallow just yet. Combine this with guidance that shows a more modest growth and a projected loss next quarter and it is clear that investors will still be gunshy.
My thought on Pandora is that they will outperform their guidance while posting an even better EPS than the loss of $0.02 to $0.04 per share they are guiding the Street to. Does this make it a buy? That is the trick.
Currently I like Pandora as a buy any time it slips below $11 and as a sell any time it rises above $15. This trading range has worked well ever since the IPO, and I think is a valid strategy for the next few months as well.
Disclosure: I am long SIRI.
