Internet radio giant Pandora Media is the world’s largest Internet and mobile radio service. In June 2011, the company went public at $16 per share. Quickly after the IPO, investors drove the stock down, concerned about Pandora’s ability to generate profits and fend off the competition.
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The Pandora Business Model
The primary concern many have with the Pandora business model is that the company cannot become sustainably profitable due to the fact that the more music its users listen to, the more it must pay out in royalties. In essence, the two metrics rise in synchronicity.
Pandora has done what many Internet companies can’t- make money. Pandora posted a profit of $1.044 million in the year-ago period (on a GAAP basis, however, the company lost money due to the conversion of preferred stock). If it is true that Pandora’s revenues & expenses, rise and fall together, then how can Pandora ever generate high net income? If Pandora can increase revenue per user, net income can rise as well.
Therein lies the key to Pandora’s future success. Pandora’s ad-based model has both more risks and more opportunities than traditional radio advertising. Old fashioned radio stations buy advertising and then play that advertising to all their customers simultaneously, hoping that the station’s ad buys were a wise investment. Pandora, on the other hand, buys its ads in a more targeted manner than traditional radio, due to the tremendous amount of data it has accumulated on its customers’ listening habits. Potentially, a person’s musical interests can translate into their consumer tastes. As such, can Pandora target its ads in a much more precise manner, and charge higher prices as a result?
We could assume that Pandora can wait for ad rates to increase, and when that occurs, the profits will come flowing. Alas, it is not that simple. Pandora’s future is predicated on mobile usage, not desktop. And as such, its future income will be determined by how much it can extract for mobile advertising. And that is going to be the main challenge for Pandora going forward. Currently, Morgan Stanley estimates that Pandora brings in about $20 of mobile revenue for each hour of listening. That same report estimates that Pandora will not be able to offset its royalty payments with mobile ad sales by 2016.
Pandora should be able to successfully navigate the transition to a mobile-based world. Currently, 70% of Pandora’s usage comes from mobile, and the company has inked several partnerships to expand its reach, including deals with Acura, Kia, and Audiovox. The company had two billion one hundred million listener hours in the third quarter of 2012, and that number is continuing to soar.
Pandora, like many newly public technology companies, is not yet profitable, and for now, attracts investors with soaring revenue growth. As of the last quarter (Q3 2012), revenue grew 99% year-over-year, and the company posted revenue growth of over 114% for the first 9 months of 2011. Below is an overview of Pandora’s most recently available financial data. The next quarterly earnings release should occur some time in March. As a reminder, Pandora’s fiscal year does not align with the calendar.
|Q3 2012||Q2 2012||Q3 2011||Q2 2011|
|Subscription Revenue||$9.023 Million||$8.708 Million||$5.006 Million||$4.112 Million|
|Advertising Revenue||$65.985 Million||$58.258 Million||$32.683 Million||$26.723 Million|
|Total Revenue||$75.008 Million||$66.966 Million||$37.869 Million||$30.835 Million|
|Cash & Cash Equivalents||$90.799 Million||$95.307 Million||N/A||N/A|
|Total Assets||$169.914 Million||$165.249 Million||N/A||N/A|
|Total Liabilities||$62.285 Million||$60.823 Million||N/A||N/A|
Pandora is not only steadily increasing revenue, it is also signing up more and more paying subscribers, with subscription revenues soaring by more than 80% in the last quarter. Pandora is making itself a service that is both engaging and useful to its customers.
Pandora is effectively operating near or above break even. Unlike other high-flying Internet companies, constant rounds of new funding should not be needed to sustain the business.
Business Model Outlook
What does the future hold for Pandora? Let’s examine both the positive and negative case.
Positive Case for the Pandora Business Model
- Rapidly increasing subscriber base and usage
- Increasing revenue per customer
- Riding the Internet trend
- A better alternative to watching music videos on YouTube, so lots of market share to steal
- Just beginning to get penetration in automobiles
- Developing a potentially valuable data set
- The Holy Grail- Move to a traditional interruption-based advertising model (I bet listeners would tolerate a few commercials)
Negative Case for the Pandora Business Model
- Direct relationship between usage and cost without a corresponding advertisement revenue increase
- Is it just a cool Internet toy at the peak of trend?
- As users get savvy about the service, usage per user will increase without increased ad revenue
- Relatively low barrier to entry- As Pandora attempts to increase revenues, users become annoyed and matriculate to a knock-off service
- It’s still a play in the unprofitable music business
- One word- Apple
Do you believe the Pandora model will work well long term? Why or why not?