Pandora's Three Biggest Issues Are Both a Blessing and a Curse

NEW YORK (TheStreet) -- When it comes to Pandora  (P), it always comes down to one of three things, at least for investors.

At times there might be a slowdown in advertising revenue or a decline in total listeners. And then there's the nagging issue of music royalties -- not to mention newfangled competitors such as Spotify and Jay-Z's Tidal or perhaps the inevitable relaunch of Apple's (AAPL) Beats streaming service.

"People are always concerned about all three, and at any single moment there's always one that's not aligning," Amy Yong, media analyst at Macquarie, said in a phone interview. "People are either worried about competition or costs or growth."

For the past three months, though, shares of Oakland, Calif.-based Pandora, the Internet's largest radio service by users, have been on a rebound, gaining 22%. The jump is largely tied to Pandora's ability to show signs of sustainable growth even though the company remains unprofitable, having lost 12 cents a share in the quarter ended March 31; Wall Street's sell-side analysts had been expecting a 17 cent loss.

But the focus with Pandora remains on its ability to grow, and advertising sales surged 27% to $178.7 million in the first quarter while total listener hours increased to 5.3 billion from 4.8 billion during the same period a year earlier.

On Tuesday, Pandora CFO Mike Herring was at JPMorgan's tech media and telecom conference in Boston trumpeting Pandora's acquisition of online music-analytic service Next Big Sound. Its sophisticated computer platform, he said, will be able to supply musicians with data about the streaming of their songs and afford marketers more data about how effectively their advertisements are being consumed.

As is the case for most digital-media content providers, growth increasingly depends on maximizing the reams of data compiled about users -- totalling some 79.2 million for Pandora as of March 31. For Pandora, advertising is especially important because the great majority of its users choose to listen to ads rather than pay for a subscription to avoid them.

"The low-hanging fruit for Pandora is trying to penetrate radio advertising, which is an $16 billion-a-year business," Yong said. "They're still pretty new there."

One thing Pandora has in spades is advertising inventory, which could be allocated for all sorts of advertising, especially video ads, Herring said. To sell more advertising, Pandora has expanded its sales force by 100 -- bringing its ranks to more than 430 in local markets -- and has begun to put more of its advertising on automated or programmatic advertising platforms enabling it to sell that airtime through sophisticated computer programs, he said.

The typical Pandora user is listening to the service 22 to 23 hours a month, yet the company has only recently begun to demonstrate that it can make money off of all that listening.

"Pandora is going to develop a lot more advertising opportunities that leverage what is natively strong about Pandora," Herring said at the conference. "Programmatic, in mobile, is a big piece of that. We've launched those platforms now.

"We're optimistic that those are going to open up some new demand around display and mobile in particular, an area where we have a lot of inventory and relatively [have] been undersold there," he added.

Yet Pandora remains in limbo on its biggest piece of overhead: royalty fees, which comprise about 50% of costs, Yong said. Herring recently testified before the U.S. Copyright Royalty Board, which is readying a decision about the amount of money that services such as Pandora must pay music publishers and songwriters to air their works.

Sometime later this year, the board is expected to set music-licensing rates for the 2016-2020 statutory period. Pandora has been pushing for rates that are roughly one-half the amount being requested by SoundExchange, a digital performance-rights organization that represents thousands of musicians.

For investors, Pandora's ability to control costs will go a long way to determining its profitability. 

"If they can control costs, which is royalty fees, Pandora is a home run," Yong said. "Growth isn't an issue; it's really costs." 

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