Turn Down the Radio – Pandora Media Inc (P): Sirius XM Radio Inc (SIRI)

In recent years, the radio industry has evolved tremendously, given constant changes in technology and improvements in internet speed. One such company that has monetized this trend is Pandora Media Inc (NYSE:P).

Pandora provides Internet radio service in the United States, offering a personalized experience for its listeners. As of Feb. 2013, the company had 67.7 million active listeners, an increase of 37% from 49 million last year. How does it work? It has pioneered a new form of radio under which one uses intrinsic qualities of music to initially create stations and then adapts playlists in real-time based on the individual feedback of each listener. It also runs a premium service that provides advertisement-free access to music. It earns its revenues from advertisements and premium service subscriptions, and its main costs include royalty on music content.

Pandora Media Inc (NYSE:P) recently announced that its 4Q results exceeded Wall Street’s expectations, and the stock jumped 20%. It also announced that its CEO Joseph Kennedy will step down.

4Q12 Results

4Q12 total revenue increased 54% y-o-y to $125.1 million.  Advertising revenue was $109.0 million, a 51% year-over-year increase.  Subscription and other revenue was $16.1 million, a 74% year-over-year increase.

Pandora’s advertising revenue growth was directly impacted by its ability to monetize mobile listening hours. Further, growth in mobile advertising revenue exceeded growth in mobile listening hours, reflecting its improving monetization of mobile content.

Content acquisition, Pandora’s largest component of cost, increased 60% to $76.7 million and was 61% of its total revenues. Marketing and sales expenses also increased 63%. As a result, Pandora posted a net loss of $14.6 million .

Pandora Media Inc (NYSE:P) continues to post net losses and its 4Q12 loss has widened from $8 million last year to $14 million.  Despite the huge loss, its share price was up 20% post-announcement of 4Q12 results, and has increased 40% in the last three months.

Bulls are pointing towards the 111% increase in mobile revenues, showing the capability of the company to monetize this platform (which has tremendous future opportunities). However, the increasing cost of royalties is being ignored. Pandora is facing limited margins because in order to drive traffic or increase its advertisement revenue it has to compromise on the price. It has phenomenal growth in its revenues but it has not been able to pass it down to the bottom line.

Moreover, the company recently announced that it has introduced a cap of 40 hours on free listening hours. Thereafter, listeners would be required to pay a rental of $0.99 or subscribe to its premium services. Concerns have been raised that this attempt may reduce its listeners, but Pandora Media Inc (NYSE:P) management believes that this cohort accounts for only 4% of its total listeners, and as such will not be affected.

The company is taking drastic steps to improve its business model and margins. It is focused on 5 growth objectives: building its sales force, increasing utilization of its ad inventory (which is highlighted by the increase in RPM of $23.83), developing innovative and scalable products (for instance, the recently launched Pandora 4.0), expanding internationally (Pandora expanded its service in Australia and New Zealand) and expanding distribution (now available through more 760 consumer electronic devices and over 85 vehicle models). Furthermore, the company has been pushing for a controversial bill in Congress called the Internet Radio Fairness Act that is aimed at reducing the royalties that Internet radio companies have to pay. However, according to recent developments, it seems that the bill is dead now.