The first thing that an investor should look for when researching a company is a business model that makes sense. This is more important than brand awareness or active users or whatever other metric is touted by the company in question.
Internet-radio company Pandora Media Inc (NYSE:P) is a great example of a company with wonderful-looking metrics but a fatally flawed business model, and the most recent quarter has shown that the company is getting desperate.
Growth is a double-edged sword
It’s relatively easy to spin Pandora Media Inc (NYSE:P)’s earnings results into a positive. Revenue rose by 55% year over year as advertising revenue grew by 44% and subscription revenue grew by 153%. Non-GAAP mobile revenue jumped 92% year over year as the company has made great progress targeting mobile users. Listener hours rose by 18% year over year to about 3.9 billion and active users grew by 30% to 71.2 million.
Another thing that’s growing is the share count. The weighted-average diluted share count grew by nearly 5% year over year, meaning that a share of the company bought one year ago now represents a reduced ownership stake in the company.
Volume doesn’t solve the problem
The vast majority of Pandora Media Inc (NYSE:P)’s users don’t pay the company a dime, and Pandora monetizes that user base via advertisements. Advertising revenue made up 81% of revenue in the quarter, with subscription revenue accounting for the rest.
The problem that Pandora Media Inc (NYSE:P) seems to have is that the company is losing money every time a user streams a song. Costs are rising just as fast as revenue, and in fact faster than advertising revenue, so simply adding more users doesn’t help profitability.
In Pandora Media Inc (NYSE:P)’s latest earnings call, the company announced that it was lifting its 40-hour limit on non-subscribing mobile users, a policy which was only in place for six months. This policy was originally put in place because increasing royalty rates made free unlimited listening untenable. Although the company states that strong advertising revenue is the reason for the policy being scrapped, I suspect that there is another reason: Player Two has entered the game.
The growth story may be over
There are plenty of competitors in the market already, such as Spotify, Slacker Radio, and a slew of start-ups. But Pandora Media Inc (NYSE:P) has remained a popular choice for Internet-radio streaming even as other services gain traction. This could very well end with tech juggernaut Apple Inc. (NASDAQ:AAPL) getting into the game: Apple is set to launch iTunes Radio in September.
Looking at Apple Inc. (NASDAQ:AAPL)’s website detailing the service, it becomes clear that it will be very similar to Pandora Media Inc (NYSE:P). One positive for Pandora is that iTunes Radio will not be available on Android devices, although it will be available on PCs. iTunes Radio does have some unique features, such as Siri integration and the ability to buy songs and add them to an iTunes collection with ease. But the concept is essentially the same as Pandora.
iTunes Radio will have an ad-supported free version, but a subscription to iTunes Match will allow users to listen ad-free. iTunes match is Apple Inc. (NASDAQ:AAPL)’s cloud-based music-syncing service, which allows you to access your music collection, whether bought on iTunes or ripped from CDs, on any device.
iTunes Match costs $24.99 per year, less expensive than Pandora Media Inc (NYSE:P)’s $36 per year ad-free subscription. I doubt Apple Inc. (NASDAQ:AAPL) will make much money directly from the service, but its tight integration with iOS 7 is a selling point for Apple devices. And the record labels which own the content are likely thrilled with the ability to buy songs directly from the app.
The bottom line
My opinion for quite some time has been that a business based on paying royalties for content which is then streamed doesn’t make much sense as a stand-alone company. If these streaming companies began to make a considerable profit, the owners of the content would likely demand more money, reducing profits back to piddling levels.
As part of a broader ecosystem like Apple Inc. (NASDAQ:AAPL)’s, an Internet-streaming service makes sense, but I don’t think a stand-alone company like Pandora Media Inc (NYSE:P) will ever consistently earn meaningful profits. I’m not sure what investors see in Pandora, but I see a failed company waiting to happen.
The article Pandora Is Getting Desperate originally appeared on Fool.com.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Apple and Pandora Media. The Motley Fool owns shares of Apple.
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