- A low probability of achieving 2020 revenue targets through subscriber growth and new businesses ventures.
- Continuing annual losses due to required revenue sharing with record labels.
- A large cost to develop a competing streaming service in an already crowded market.
On March 28th, Pandora Media (NYSE:P) announced that Tim Westergren, a co-founder of the internet radio pioneer, will return to the company as CEO, replacing Brian McAndrews. In the past six months, investors have pushed Pandora's stock down 50% amidst fears of strong competition from Spotify and Apple Music. Unlike Westergren, who previously served as CEO between 2002 and 2004, McAndrews had no prior music experience having worked at the likes of Microsoft, General Mills, etc. Will Westergren's return to the helm reinvigorate and rescue the company?
2020 Revenue Targets
During the 2015 annual earnings release in February, Pandora's management stated the company has a 2020 revenue target of $4 Billion. How likely is Pandora to reach this target?
The majority of the company's current revenue is generated through subscription and advertising sales. In the most recent fiscal year, Pandora generated $1.1 billion; a $200 million or 26% increase from fiscal year 2014. Pandora's second revenue channel is newer and much smaller. In October 2015, when McAndrews was leading the company, Pandora acquired ticketing startup TicketFly for $450 million in cash and stock. Pandora is currently forecasting that TicketFly will generate $300 million in revenue in five years.
How likely is the company to meet these two revenue targets?
Assuming a continued compounded annual revenue growth rate of 26%, subscription and advertising sales would generate $3.7 billion by 2020. Possible, but not likely to happen.
Unlike print magazine subscriptions, consumers are unlikely to pay for multiple online music services. Why would an individual subscribe to Apple Music for on-demand music and Pandora for radio? The rapid ascent of Apple Music and Spotify reduces growth opportunities for Pandora. Apple Music launched in June 2015 and is already projected to generate $1.2 billion in 2016; more than Pandora generated in 2015 even though it launched a decade earlier. Can Pandora realistically achieve 26% annual compounded growth while competing with Spotify and Apple Music?
Investors would hope that TicketFly revenue can hit $300 million in five years, but that is also not likely to occur. In 2015, TicketFly generated $10 million in revenue. Growing to $300 million in five years would require a 97% annual compounded growth rate. For comparison, ticketing revenue for LiveNation in 2015, parent company of TicketMaster, was $1.7 billion with an annual growth rate of 10% versus 2014 (using constant currency). Assuming TicketMaster continues to grow at a 10% annual compounded rate, in five years Pandora is forecasting that TicketFly will own nearly 11% of the ticketing market (compared to TicketMaster) versus its current 0.5% market share. This growth target is extremely aggressive and unlikely to occur.
Similar to many technology companies, profits have thus far alluded Pandora. Since going public in 2006, Pandora has lost money every fiscal year with 2015 having the highest annual loss yet.
As mentioned above, the majority of Pandora's revenue engine is derived from subscriptions and advertising. Unlike Spotify and Apple Music where listeners can pick the song to play, Pandora is a radio station and thus subject to pay a royalty rate for it's services. This rate is set by a tribunal of judges at the US Library of Congress. Spotify and Apple Music, which are not radio stations, are not subject to this law and negotiate their own rate with studios directly.
Based on a ruling in December 2015, the royalty rate that Pandora must pay will increase by 21% and will then adjust with inflation yearly until 2020. In 2015, this royalty cost consumed nearly 50% of Pandora's revenue. Even if Pandora is able to greatly increase its subscribers and listener hours, a large amount of the revenue will be paid for royalties. Pandora's largest business cannot achieve economies of scale. This will likely lead to continued annual losses.
Streaming Service Cost
As mentioned above, Pandora is not an on-demand service like Spotify and Apple Music but rather a radio station. In order to compete with these larger services, Pandora announced it will launch a Spotify-like clone in 2017. The company acquired key assets from Rdio for $75 million last year and will spend an additional $120 million on development. The combined cost for the Spotify clone, if on budget, will be nearly $200 million.
When Pandora's on demand product launches, it will be competing against incumbents Apple Music and Spotify. In addition to the high development cost (10% of the company's market capitalization), a large (i.e. expensive) marketing campaign will be required to lure in customers. Pandora's on demand service will likely lose money for the foreseeable future. Pandora's internet radio business launched over 10 years ago with no competition and still has not generated an annual profit. Pandora's on demand service will launch with entrenched incumbents. How long will it take for that service to be profitable?
The return of Tim Westergren as Pandora's CEO is undoubtedly a positive development for the company. Brian McAndrews stood by while Spotify and Apple Music stole the limelight, immensely overpaid for a company that generates minimal revenue (TicketFly) and was unable to earn a profit.
Investors should not expect that Westergren's return will be sufficient to save Pandora. The company's revenue targets (given by McAndrews) seem unrealistic, it's royalty costs will continue to siphon away nearly 50% of revenue and it's Spotify-like service will launch into a very crowded market. Absent an acquisition, Pandora is likely to continue to underperform.