For nearly a decade, Pandora Media Inc (NYSE:P) has stood alone in the world of online music streaming, a breakthrough technology for its time. The ability to stream whichever song one chooses straight onto one’s computer for free was warmly received, and when that ability moved to mobile phones, it only grew further.
Pandora Media Inc (NYSE:P) Radio, thanks to a blanket license issued by Congress for online streaming services, has been in the driver’s seat for much of the time. With news coming out that Google Inc (NASDAQ:GOOG) will be releasing its own streaming service and that Apple Inc. (NASDAQ:AAPL) is trying to develop one of its own, though, the big question is whether or not Pandora can compete against the two giants of the tech industry.
Some are already writing Pandora Media Inc (NYSE:P)’s obituary, pointing to the company’s struggles to turn a profit due to high royalty costs and numerous free users, as well as the potential loss of customers to Google and Apple, but I think Pandora has more staying power than people would like to admit.
Improving outlook for Pandora’s balance sheet
In Pandora’s first quarter earnings report, released on May 23, the company may have seen a decline in earnings-per-share, or EPS, by $0.16/share, as royalty costs are mounting for Pandora. However, there was a lot of good news in the recent earnings report that investors should be looking at for Pandora Media Inc (NYSE:P)’s long term growth. Mobile advertising revenue, the main fundraising mechanism for free Pandora users, doubled to $83.9 million, as the numbers of hours listened to Pandora on mobile devices grew 47%.
More interestingly, according to Chairman and CEO Joe Kennedy, the gamble to place a 40 hour limit per month on free usage has had the effect of both limiting royalty payments on free access to music, as well as getting people to subscribe for the ad-free Pandora One service. At a cost of $4/month, or $36/year, listeners can use Pandora without commercials and without streaming limits. This has helped not only limit royalty costs Pandora incurs, but it has also led to 700,000 more subscribers for the service last quarter. This is crucial because it should lead to fewer royalty costs this year.
This high subscription conversion rate could increase with time, especially for mobile listeners, and give Pandora the ability to stay competitive once Google and Apple jump into the mix. Earnings for the year should jump as well, and according to financial chief Mike Harring, earnings-per-share may jump as high as $0.08/share, with median estimates closer to a $0.02/share increase, which analysts want to see. This leads to projections of yearly revenue of $615-$635 million, which combined with the royalty curbs and increased subscriptions, should put Pandora in the black by this time next year, just in time for the new competitors to jump in.
Google’s name won’t guarantee Pandora converts
Pandora Media Inc (NYSE:P) does have some distinct advantages against the two other competitors. Google’s “Play Music All Access” has the advantage of Google’s expansive ecosystem of customers who use Google Inc (NASDAQ:GOOG) for nearly every technological function imaginable. Interactivity with Google’s cloud software is also a benefit, but the new service has some flaws.
For one thing, Google is charging $10/month for the service, with an introductory rate of $8/month. This is more than twice the cost of Pandora, even though Google will have a more expansive library from the outset. While this seems like a draw that will justify the cost, many Pandora listeners have been satisfied, even with the limiting of the free options, which is what Google Inc (NASDAQ:GOOG) doesn’t have. For casual listeners, the free Pandora software with ads every now and again will be more than sufficient, and for Google, it will be hard to wrench some of Pandora’s 200 million users away from Pandora’s own ecosystem.
If it keeps up, Pandora’s high subscription conversion rate will hearten Pandora Media Inc (NYSE:P) investors. It could show that free Pandora users are more than willing to stay with what they know than switch to a more expensive service if there is no need to do so. Therefore, while I expect Google to have its customers from its own ecosystem, brand loyalty to the pioneering Pandora will help the company stay competitive, and Google may not see the boost in profits or share price that it is expecting from the launch of this service.
Apple struggles to woo record labels
Apple’s proposed iRadio, which will be similar to Spotify’s streaming service, is running into problems with publishers and record companies. While Pandora caught a break with a government-approved license for streaming, Apple Inc. (NASDAQ:AAPL) is having a hard time wooing music publishers, as many labels are seeing flatter returns on music sales since the dawn of online streaming. It doesn’t have Pandora’s luxury of being the first mover in the industry either. Lastly, Apple Inc. (NASDAQ:AAPL) will also be in a bind because of Google’s wide appeal through Android phones and much larger ecosystem to draw customers from.
I expect Apple to have success though once it reaches agreements with the labels that work with them on iTunes, Apple’s still very popular music service. This will give iRadio a real leg up if there is the ability to connect with established playlists and the Genius software built into iPhones and iTunes. It would also help Apple’s innovation problem settle quicker, which has been seen as a drag on company profits and share price, meaning that it would be a better earner for investors than Google, simply because expectations are lower for Apple as of late.
The bottom line: Pandora is better than you think
Pandora will have some stiff competition in the future, but this company is by no means doomed, as some might think. A solid first quarter has helped the company’s image in the eyes of investors, and the gamble to limit free hours has been successful for getting people to pay for a subscription.
With improving mobile advertising, the affordability of Pandora Media Inc (NYSE:P)’s pay service, as well as strong evidence of brand loyalty by its users, it stands to reason that Pandora will be more than able to stand up to Google and Apple in the online music market. Not only that, since Pandora is a one-function company, while Google and Apple are multi-headed beasts, there will be more incentive to innovate on Pandora’s part, while innovation for Google and Apple may be diverted to the smartphone industries, a more lucrative field for these two companies.
If Pandora can turn a profit by next year, something that is attainable according to management, it can not only survive, but also thrive. As the first company in this industry, it has an established following that won’t go away anytime soon, and those looking for a Google-lead death blow for the company will be disappointed. Meanwhile, investors who remain faithful to Pandora Media Inc (NYSE:P) will be rewarded over the long term as the company matures.
The article Why Pandora Isn’t Doomed originally appeared on Fool.com and is written by John McKenna.
John McKenna has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. John is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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