Pandora Offers Enough Positives to Paint Rosy Picture of Steady Growth

Despite second-quarter sales that trailed expectations, Pandora said its on-demand subscription service due in late 2016 will bolster sales among a more active user base of 78 million listeners.
By Leon Lazaroff ,

Pandora Media (P) continues to get the benefit of its assorted doubts.

For the second quarter, the Internet radio service posted revenue of $343 million, a 20% increase but a total that fell short of analyst forecasts of $351.7 million.

And while listener hours increased 8.6% to 5.66 billion, total active listeners dropped to 78.1 million from 79.4 million in the second quarter of 2015,. And while Pandora has yet to operate in the black, its loss for the quarter of 12 cents per share was narrowly better than expectations for a loss of 15 cents per share.

In the words of Morgan Stanley media analyst Benjamin Swinburne, "a mixed-bag quarter."

Nonetheless, CEO Tim Westergren showed why the company's board brought back its co-founder in March to take over as chief executive. Westergren, on a conference call with investors, drew a portrait of a company poised for a growth spurt on the backs of a more dedicated user base.

Pandora, which gets most of its revenue from advertising, has branched-out over the past year into ticketing and concert promotion, and is preparing to launch an "on-demand" subscription platform in the fourth quarter that would compete more directly with privately-held Spotify and Apple (AAPL) - Get Report Music.

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Speculation about that forthcoming platform combined with a report of a possible takeover bid from John Malone's Liberty Media was fueling a 4% gain on Friday to $12.48, thereby trimming its 2016 decline to 11%.

"So our strategy in front of us it to offer this broader product, and we want to have our audience as large as possible when we hit that and bring that to market," Westergren said on Thursday in an investor conference call. "We're timing [the on-demand platform] to hit the market, so that when we do bring new products to market, we're in a perfect position to be there."

Shares in the Oakland-based company spiked on Thursday after The Wall Street Journal said Liberty Media (LMCA) , owner of the satellite-radio service Sirius XM, had recently floated the idea of acquiring its rival for $15 per share. The mere possibility that Malone and Liberty CEO Greg Mafei might be interested in buying Pandora was more than enough to offset a modest earnings report.

"Recent changes to the board/management, talks of consolidation in the air again, and investor activism could accelerate value creation," Macquarie media analyst Amy Yong said in an investor note. "With an informal offer from Liberty to combine with Sirius XM, we think the pressure to deliver is high."

Liberty Media would seem like a natural fit for Pandora given that it owns Sirius XM, a profitable subscription-based business that has leveraged partnerships with automakers. Pandora is also working with automakers to have its service installed in new vehicles. Yet unlike Sirius which costs $15 per month, Pandora's ad-supported platform is free. (Pandora also offers an ad-free service called Pandora One priced at $4.99 per month.) 

Since returning to Pandora, Westergren has sought to grow Pandora's audience, most notably signing a deal with Uber to allow drivers in the U.S., Australia and New Zeland play music for free without ads. More than 50,000 Uber drivers are using Pandora with average daily listening exceeding 2.5 hours per day per user.

Pandora set its own new record of 24 hours of listening per month for each listener during the second quarter. The upturn, the company said, was due in part to adoption of its Thumbnail Radio feature which converts a listener's favorite songs into playlists as well as the increasing popularity of voice-enabled devices such as the Roku 3 and the Amazon (AMZN) - Get ReportEcho.

Yet even as engagement continues to climb, questions remain about Pandora's ability to increase advertising sales. Ad revenue in the second quarter trailed expectations, increasing just 15% to $265.1 million. Lower-priced national ad-sales were to blame. 

For the current quarter, Pandora said revenue is likely to fall within a range of $360 million to $370 million, short of the $378.2 million average of analysts' estimates as compiled by Bloomberg. And for all of 2016, Pandora's projection of revenue between $1.39 billion and $1.41 billion also trailed estimates.

This failure to "monetize" Pandora's increased listening remains the company's achilles heel. Yet over time, Westergren said Pandora's ad sales should grow as it increases its ad-load and generates more sales through higher-priced local categories. And on-demand subscription service should also help.

Unlike Apple, he said, Pandora can strike more favorable deals through direct talks with music labels because an on-demand subscription platform will be supported by its parallel ad-based service. Apple, by comparison, plans to use rates set by the U.S. Copyright Royalty Board.

"We come to this as a core profitable product ad supported that has this high engagement and allows us to enter the market in a different way," Westergren said. "And it allows us to offer economics that are healthy for us but also healthy for the business. But Apple's proposal - we don't think there's a one-size-fits-all business. So we're doing our deals directly."

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