It’s Dark Inside Pandora’s Box
Rita is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Is there really any value in earning millions if the expenses are in billions? I guess not. Similar is the case of Pandora (NYSE: P), the online radio service provider, which recently came out with its fiscal 2013 second quarter results. The company surprised and shocked everyone at the same time as it reported stupendous growth in several business areas and yet reported a disappointing bottom line. Let’s take a look into Pandora’s latest quarter and then decide what’s in it for the investors.
The Quarter and its Numbers
The internet radio giant reported a brilliant top line growth of 51% from the prior year period and ended the quarter with revenue of $101.3 million and this was also matching with the street’s estimates. Along with this, total revenue from mobile offerings also increased by a whopping 86% while the active user-base reached the 54.9 billion mark, up from 37 million of the year ago quarter, suggesting a 48% growth rate. The quarter was special for Pandora also because its market share increased to be above 6% as against 3.5% witnessed last year. Despite this Pandora reported a loss per share of $0.03 on a GAAP basis, while the non-GAAP EPS stood at $0.00. The dismal bottom line had to do all with the rapidly increasing content acquisition cost which jumped almost 80% to $60.5 million from $33.7 million in 2012 Q2.
Content acquisition cost is a core business cost for Pandora’s business model. Every time a user plays a song, Pandora needs to pay the artist for the song. Thus, the huge increase in the subscriber meant both good and bad for the online radio service provider. With the increase in the number of users and also with the 80% increase in the total listener hours, the cost for acquiring the media content also went up a lot and pulled down the otherwise strong margins. As a percentage of total revenue also, the cost increased from 50% in the prior year period to 60% in this recent quarter.
Pandora and Competition
Unlike its peer Sirius XM (NASDAQ: SIRI), Pandora failed to sport good cash generation also. While the satellite radio provider Sirius’s free cash surged as much as 39% and resulted in a all time high of $230 million in its second quarter, Pandora reported a very nominal free cash of $0.2 million. Sirius is turning out to be a serious competitor for online radio providers such as Pandora and Spotify as the company witnessed a net subscriber addition of 622,000 alongside a low churn of 1.9% for its self-pay offering. Sirius is even planning on bringing out an app for smartphones and tablets which will allows users to access Sirius’ contents at a nominal $3.50 per month after 7 days of free usage and this move can hurt Pandora big time.
Pandora’s top line was boosted hugely by the advertising revenue which accounted for 88% of the total revenue while subscription and other revenues contributed the remaining 12%. Out of the 88%, 58% was contributed by mobile users and 30% was from desktop users. So, if Sirius’ app gets picked up by more and more mobile users, Pandora’s future revenue might see some tough times. The online radio company depends hugely on its ad income to offset the impact of the rising content acquisition expense and even then it seems to be not enough. Even Apple (NASDAQ: AAPL) is expected to enter this online-radio space soon and if that happens, Pandora might find itself in deeper trouble.
Pandora’s business model is such that with increasing subscription, costs will also increase. So, the only way left to pull out the bottom line from the loss to the profit zone is to push up the ad revenue. Unless Pandora comes up with a way to generate more ad revenue, the company is likely to see a hard time. Though management is pretty happy about the growth across several business lines, the revised annual guidance still isn’t looking satisfactory as the company is expected to suffer a loss per share between $0.04 and $0.08.
The company is surely taking steps to ensure ad revenue growth by attempting to expand to Australia and New Zealand and capturing a large subscriber base there to attract more advertisers. Yet, with costs growing at a rate higher than revenue growth and with poor cash generation and wealth creation for the shareholders, Pandora isn’t looking attractive. It’s not known how soon the expansion efforts of the company will result in improved margins and as of now the short-term future is looking dark.
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