Pandora Prevails Even Against Apple

  • Pandora remains one of my favorite ideas despite competition.
  • The company’s execution on pricing and local advertising has materialized.
  • Furthermore, I continue to believe Pandora was conservative on guidance and is insulated from competition.

Pandora Media (NYSE:P) had a fairly solid quarter, but what was more noteworthy was the sustained 19% y/y growth regarding RPMs (revenue per thousand hours of listening). RPM is the primary metric by which analysts are determining the timing of break-even point since licensing cost per thousand hours will remain at a fixed level of $32.

Furthermore, the new CEO of Pandora made a relatively solid introduction on the Q1’16 conference call. I believe that under the watchful eye of Timothy Westergren (the new CEO and former co-founder), the company will perform considerably better. Timothy mentioned his extensive experience as a musician and even elaborated on how he’s going to navigate higher costs with rapid execution on sales. It’s a good sign because that’s the only way out of this situation.

So, there’s an actual silver lining to all of this

The relatively healthy growth trajectory in a seasonally weak period was what bolstered market sentiment. Sure, institutional interest has waned over the years, but those who are familiar with the company are likely piling back into the name. In the Internet space, sometimes it’s better to go small than to go big. And in this specific case, I believe there’s still plenty of runway for driving RPM metrics, as I have modeled a scenario of sustained 20% annualized growth over the next five years.

I rationalize this given the relatively low ad pricing when working backward to make comparisons on a cost per thousand impression basis. Since Pandora monetizes its service at $45.47 per thousand hours, it leaves plenty of room to boost pricing upon better implementation of ad technologies and self-serve platforms. That being the case, at roughly seven ads per hour, the company serves roughly 7,000 ads per thousand hours, so if we divide that figure by the RPM, the company is selling each impression at approximately $.00649. And yes, that’s slightly more than half of an Abraham Lincoln penny. To readjust for standard industry ad units on a cost per thousand impression basis (CPM), I multiply the figure by 1,000 impressions to arrive at an average CPM of $6.49.

The average CPM of video formats is $24 according to eMarketer, so radio advertisements are still viable on a comparative cost basis with enough room for upside. Furthermore, live content generally attracts higher bids, as there’s a more engaged audience. As such, I’m still bullish on growth prospects.

Competitive landscape not as formidable

While others aren’t so convinced in the opportunity, I believe the competitive threats while worrisome can be overcome given the relatively minimal impact of active user churn even after the launch of Apple (NSDQ:AAPL) Music. It’s worth noting that Pandora grew active listeners from 79.2 million to 79.4 million in Q1’16 on a quarter on quarter basis. This is after Apple tacked on 11 million subscribers, according to Eddie Cue himself (back in September 2015). In Q4’15 Pandora reported 81.1 million active listeners, so even though Apple gained 11 million users, it didn’t have any serious impact on Pandora’s installed base. In other words, Apple failed to gain significant market share, which is very unusual given its track record of “big hits,” but lately, it’s been “big misses.”

As such, I’ve been lamenting about Apple’s lack of transformative success in organically grown franchises under Tim Cook’s stewardship. Just where did Apple’s magic go? Somehow, Apple must have lost its teeth in the process of launching so many products, because if they can’t rip to shreds an ant-sized company (comparatively) we might as well bust out half of a 1990’s movie script, “Houston we have a problem.” But then again, Pandora always had a strong franchise in digital radio, especially when compared to Apple Music. This can be blamed on Apple’s management team as they were slow to execute on digital streaming. Wasn’t it the over-emphasis on cost savings and over-milking of revenue streams the problem in the 90s? And… here we go again, they over milked iTunes and rationalized the launch of a streaming product in 2015…. Exactly ten years after YouTube was a thing.

At the rate this is going, it may be decades before Apple witnesses another visionary executive that’s roughly comparable to Bob Iger or Mark Zuckerberg for that matter. I doubt Wozniak will make a reappearance nor is he a managerial type. Tim is a great manager and orchestrates his knowledge of finance/supply chain superbly. But is he a visionary product genius? No. He just doesn’t know how to micromanage developer teams, as he’s not Steve Jobs. I doubt Steve would have let a small radio app survive, or Spotify for that matter. But what did Tim do? He turned Apple into Goliath whereas little David is still slinging and singing “Hallelujah” through a digital radio app.

Cue and Cook were slow to execute, and that’s been Apple’s biggest problem in music. They are the type of managers capable of rebranding pre-existing categories with Apple’s logo, but unable to create successful new categories. Innovation is dying, and the marginal improvements made weren’t leaps and bounds ahead of competitors. It has gotten to a point where a little radio app can stand up to the might of the biggest company on earth. What’s even more baffling is that I’m more optimistic on Pandora than Apple lately. If someone told me this was going to happen two years ago, I would have died from all the chortling, no seriously.

Key analyst commentary coming out of the quarter

So, the analyst commentary on Pandora was pretty interesting. Analysts moved slightly higher than the company’s high-end of revenue outlook, so model revisions were made, but not too significant. So, I’m going to focus on more of the qualitative aspects of the consensus dialogue as opposed to the quantitative:

The change at the top clearly created investor concern a month ago, with Pandora’s share price tumbling following the announcement. However, Pandora’s share price has recovered to pre-management change levels, suggesting that Mr. Westergren’s limited experience as CEO is not as concerning to investors as it was when the management change was made. It is clear that Mr. Westergren’s vision for Pandora is to create the best experience for Internet radio, and we think that the company has largely succeeded in achieving this vision in the U.S. In our view, Pandora’s recent rate setting decision from the CRB positions it to expand Internet radio to other countries. – Michael Pachter from Wedbush Securities

We view Pandora’s Q1 monetization trends positively, as the company managed to maintain Total Advertising RPM and Listener Hour growth. We believe Pandora will continue to have an increased focus on local ad sales (which garner meaningfully higher RPMs than national ads). – Mark Mahaney from RBC Capital Markets

Very salient points by both analysts. It’s likely that Pandora’s mix shift to local ads will be a key component to sustained RPM growth for the foreseeable years. Furthermore, it’s worth noting that Westergren’s presence is respected inside and outside of the company as well.

Final thoughts on the quarter

That being the case, I wanted to close out by mentioning that Pandora was extra conservative on the revenue outlook. If they beat by $10.81 million and their outlook range increased by $10 million at both the low and high end, it means they’re not factoring additional sequential growth above prior forecast (after sustaining q/q growth between Q4’15 and Q1’16). Growing between Q4’ and Q1’ is very uncommon due to seasonality. Therefore, Pandora’s growth trajectory will likely steepen through the year given all the aforementioned factors in this article. Pandora will likely acrobatically jump over its own guidance (later this year) with comments like, “easier than expected compares and great execution on ad pricing.”

As such, I reiterate my high conviction buy recommendation and $11.87 price target.

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