Pandora May Turnaround Its Declining User Figures

  • Pandora will struggle to contain declining usage metrics.
  • However, it seems Pandora is committed to generating user growth through marketing.
  • I don’t anticipate the company to surprise on bottom line metrics but will instead shift its priority to turning around user figures as opposed to improving profitability.
  • Assuming low single digit or flat active user growth metrics, investors may look past the weak earnings print out and buy Pandora stock.

Going into Pandora Media (NYSE:P) earnings on Thursday, 11th Feb, after the market close, I feel fairly confident that the commentary on user retention metrics will be the most important earnings theme coming out of the Q4’15 call. For the most part, the company has exhibited fairly stellar growth through FY’15 as a result of a 30% improvement to RPMs (revenue per thousand listener hours). The company rolled out better comparative metrics on ad pricing relative to local market radio. However, the company’s subscription product growth is starting to slow.

The company mentioned that it has a goal of reducing its sales and marketing spend from 30% (current) to 20%. The message seems somewhat conflicting given the potential risk of losing subscribers. The active listener figures barely grew by 2% year-over-year in the most recent quarter and declined sequentially. The management team mentioned that they had to increase marketing spend in the past quarter to generate some year-over-year growth. In other words, I find it highly unlikely that the management team can simply lower marketing expense without risking a further reduction in the total number of active users on the platform as such investors shouldn’t anticipate a magical recovery to profitability.

Wedbush analyst Michael Pachter reiterated his outperform rating:

We expect revenue of $328 million, Adjusted EBITDA of $29 million, and EPS of $0.10, vs. consensus of $332 million, $28 million, and $0.07, respectively. This compares with guidance for revenue of $325 – 330 million and for Adjusted EBITDA of $25 – 30 million. Our estimates assume listener hour growth of 3%, in line with guidance, and ad revenue growth of 23% driven by increasing local advertising mix.

Pandora does have rapidly growing revenues, but I don’t see massive improvements to profitability in the near term. The company will most likely report a miss on EPS given the shaky commentary on marketing spend. Furthermore, active listener growth will need to grow higher if management wants to reduce its marketing spend. In other words, I’m taking the stance that revenue could potentially surprise to a slight extent given the prioritization to user growth, but margins could suffer in the near term.

In other words, I disagree with Michael Pachter but do so respectfully. Pandora will do everything in its power to acquire additional users given the heightened competitive dynamics, and while Pandora shrugged off the impact from Apple Music on the prior earnings conference call there’s no denying they should be nervous.

I could see some near term impact from Apple not in the form of subscriber churn, but in the form of less conversion from free to paid services. However, subscription revenue only composed 20% of the revenue mix, and it seems like free mobile users later convert into Pandora One. Therefore, investors have to watch the active user growth closely. The incremental investment into marketing should impact end of year assumptions on active user figures, which could improve sequentially. If it does, the incremental marketing spend will increase Pandora’s penetration into the radio market.

I don’t see any immediate headwinds to ad pricing. The ad market can certainly support pricing increases on digital advertising, so I don’t think pricing dynamics will weaken as considerably as Pandora’s outlook indicates. Many of the other social platforms have reported solid ad pricing dynamics. The real risk to Pandora is the active user figure and whether they can improve the long-term funnel for its premium service.

P stock chart

Source: Pandora Stock Price Data by

Assuming they can (and I think they will), Pandora stock could be an interesting play at $8.40 per share. Pandora stock is cheap and is priced for broken growth. While my expectations are muted on the earnings per share print out, I think there’s a decent likelihood that the sales figure will exceed the consensus estimate. I also anticipate user growth of 1% sequentially and a 30% increase in ad-spend per thousand hours of listening, which should correspond to ARPU growth of 30%.

I anticipate the 15.3% increase in marketing spend to mitigate the churn rate and perhaps produce low single-digit growth. Advertising campaigns are surprisingly predictable in terms of conversions, so I’d be surprised if Pandora couldn’t stem the down flow of users after boosting its marketing efforts. As such, I anticipate revenue of $333.27 million, which is above consensus estimates of $331.83 million. I think margins will weaken, which is broadly anticipated by the street. As such, investors should view this as a transitional quarter, and victory will be in the form of flat or slight improvements to active listeners, which seems highly probable.

As such, I view Pandora stock as somewhat speculative. However, the decent risk-to-reward makes it an interesting buy going into earnings. Generating conversions from advertising is more science than art, and if they can turn subscriber metrics around, I feel confident that investors will be more forgiving coming out of the quarter.

Alex Cho Alex Cho   on Amigobulls :
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