Pandora Media Inc (NYSE:P)’s top line relies heavily on its active user base. It is these active users who contribute to Pandora’s earnings, thus, it becomes essential for potential investors to comprehend how growth in active users relates to its overall profits and the stock price.
Pandora defines active users as a percentage of registered users that have accessed Pandora’s services during the last 30 days from the end of each calendar month. Recently, Pandora reported a registered user base of 175 million, however, active users stood at approximately 66 million. This implies that only 38% of the total registered users were actively accessing Pandora’s internet radio services.
During 2008, Pandora reported an active user base of 7 million; however, by the end of 2012 it grew to a staggering 66 million, implying an average annual growth rate of just below 80%. The smashing success of Pandora Media Inc (NYSE:P) in the U.S. is underpinned by “personalization algorithm” and growing popularity of smart devices.
Nonetheless, the exponential growth exhibited so far by Pandora is expected to slowdown, as competitors are likely to catch up and the market will eventually get saturated.
Estimating the size of Pandora’s target market
Pandora Media Inc (NYSE:P) currently has presence across the U.S, Australia, and New Zealand. It can be assumed that the company will avoid an aggressive international expansion plan in the near-term, and instead focus on achieving profitability in its current markets.
According to the U.S. census bureau, the present population of the U.S. is 315 million, approximately. Nearly 14% of the entire population is under 10 years of age, and another 13% is above 64 years of age. Let’s assume individuals falling under these age categories are not likely to use Pandora.
This leaves us with an addressable size of 73%, which implies a potential target market of 230 million. Given that Pandora already has 175 million registered users suggests there is little room for growth within the U.S., as competitors such as Sirius XM Radio Inc (NASDAQ:SIRI), Apple Inc. (NASDAQ:AAPL)’s iTunes, and Spotify offer similar radio services.
The active user base of Pandora Media Inc (NYSE:P), which stands at 38% of its total registered users, might struggle to build any consistent momentum due to increasing competition and the company’s strategy to concentrate more on profitability, rather than just user growth.
Increasing demand for smart devices could drive the active user base
Internet-enabled mobile devices make it extremely easy for users to access Pandora’s internet radio services from remote locations. Therefore, it is no surprise that the mobile platform contributes approximately 80% to Pandora’s listener hours.
The rapid increase in demand and the popularity of smartphones has helped Pandora report exponential growth over the last few years, especially in the U.S. During 2011, total smartphone sales stood at 430 million units, and the growth continued as smartphone sales grew 47% and 38% in Q3 and Q4, respectively, of the last fiscal year.
The demand for smartphones is expected to grow at a robust pace. Pandora Media Inc (NYSE:P)’s music app on iOS, Android, BlackBerry, and Windows-based smartphones is already one of the most preferred music apps around today, hence, Pandora’s growth will heavily rely on the future demand for smart devices.
I believe the smartphone market will grow at a rapid pace, and I expect Pandora’s active user base to grow along.
Competitive threats
Pandora primarily competes with Sirius XM Radio Inc (NASDAQ:SIRI), Apple Inc. (NASDAQ:AAPL), and Spotify in the domain of radio services. Sirius XM Radio Inc (NASDAQ:SIRI) generates highest percentage of its overall revenue through satellite radio services, at around 87%. The remaining 13% is split between equipment, royalties, and advertising. The company has a market cap of $20.3 billion and trades at around 93% of its 52-week high.
Sirius’ current subscriber base is estimated at 23 million; however, according to the projections of Trefis, the subscriber base is expected to reach 36 million by the end of 2019. Further, the average revenue per subscriber by the end of 2012 was estimated at $124; nevertheless, Trefis estimates the figure to reach $174 by the end of 2019.
Similarly, Pandora also competes with Apple’s iTunes. Paying users can download content from iTunes and integrate it across Apple’s products (iPod, iPad, iPhone). It is noteworthy that iTunes and iOS contribute approximately 5.16% to Apple’s overall revenue. According to the valuation offered by Trefis, iTunes accounts for 1.11% of Apple Inc. (NASDAQ:AAPL)’s stock price.
During fiscal 2012, iOS applications and iTunes generated revenue and gross profit of $8.5 billion and $1.82 billion, respectively. Apple operated at a gross margin of 21% for the same; however, the overall gross margin for the company was at around 42% during fiscal 2012.
Importance of an active user base
Going forward, if Pandora Media Inc (NYSE:P) manages to synchronize its growth with rapid increase in demand for smartphones, then the active user base for Pandora can blow past 100 million. Nonetheless, if it stays ahead of its competitors and expands internationally, then the active user base may even report exceptional growth (130 million or above) and outdo current expectations.
According to Trefis, if Pandora’s active user base can reach a whopping 140 million, then there may be a 25% upside to its stock price. However, if it remains under the 100 million mark, there may be a heavy downside to its stock.
It must be comprehended by investors that Pandora Media Inc (NYSE:P)’s stock is extremely responsive to the growth in active user base. Other than growing its active user base, the immediate concern for the company must be to deliver consistent profits.
Going forward, in addition to growth in active user base, Pandora must control royalty costs in order to operate on high margins and develop incrementally to capitalize on the mobile platform.
The article Growth in Active User Base Will Drive This Stock originally appeared on Fool.com and is written by Ashit Gulati.
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