AT&T's New Data Plan Hits Pandora...
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…although not as hard as many people might think. There has been a wave of new anti-Pandora (NYSE: P) sentiment on various investing news websites regarding the possible implications that AT&T’s (NYSE: T) new data plan rules may have on the leading player in the Internet music streaming niche.
The telecom service provider’s spectrum problems are well documented, and it first started throttling users’ data speeds last year, whereby it would send text messages to those users who neared the heaviest 5% of data users for the month in their respective regions. The new plan, announced last week, targets AT&T’s 17 million remaining “unlimited” data plan subscribers – the company canceled its unlimited data service but allowed those who had the plan to keep it – and begins throttling data speeds once the users eat 3GB of data in a given billing cycle.
It is well known that an increasingly large percentage of Pandora users are moving into the mobile space, using Apple (NASDAQ: AAPL) iPhone or Google (NASDAQ: GOOG) Andriod powered Pandora apps to listen to music on the go. AT&T activated 7.6 million of the 37 million iPhones sold during the most recent three months ending December 31, 2011, and Google’s Android controlled more than 45% of the 149 million total smartphone sales worldwide. Pandora’s revenue stream has closely followed the continual shift away from the desktop, and more than 70% of its revenues stem from users on both mobile devices and tablets. PC users represented more than 90% of Pandora’s revenues as recently as 2009.
However, despite the slight tipping of the smartphone operating system balance shifting slowly towards Apple, and despite AT&T continuing to activate a meaningful portion of total US smartphones, the news has very minor implications for Pandora’s ad revenue generating abilities.
AT&T describes that 3GB of data translates into nearly 35 hours of streaming music – assuming that the smartphone user does not utilize any other features like sending/receiving emails, viewing webpages, downloading/updating apps, or streaming online videos. It would be reasonable to assume that average users using these other features would be able to stream considerably less than 35 hours of music per day in a given billing cycle, yet the throttling rules only apply to the estimated 5% of the 17 million unlimited AT&T users (850,000 or so subscribers).
Out of the 47 million monthly users, this implies that only 1.8% of the users will be affected by such data throttling threats by the new data plan rules. Considering the swiftly growing user base, the 850,000 subscribers that might be affected by such AT&T plan changes, although unfortunate if lost to another online radio provider, can be easily made up for. Similarly, if the new data plan rules severely hamper a user’s ability to get through a day, there is always the option to subscribe to a slightly more costly tiered plan.
The Real Issues
Seeing that Pandora shares were hit by more than 20% after hours last night regarding the corporation’s missing of analyst earnings expectations, there are obviously more pressing issues about which many are still concerned. The large drop in stock price did, after all, occur despite Pandora also announcing that annual revenues of $247.3 million grew 99% year-over-year, annual listener hours of 8.2 billion grew more than 100% year-over-year, and the active user base reached 47 million, which represented a 62% year-over-year spike. What gives?
The market is still concerned about the problems that were of issue prior to the corporation’s mid-2011 IPO:
- Online Advertising is Small, Mobile is Even Smaller
Online advertising is still a relatively small industry, representing around 13% of total United States advertising expenditures annually. Mobile advertising, which has and will continue to represent a meaningful portion of Pandora’s business, accounts for around 1% of total expenditures. Although the total market share of mobile ad spending is expected to triple by 2015, it is still a very slim piece of the pie with which Pandora is eligible for eating.
The total size of the mobile advertising industry also implies the relatively little most corporations understand about the medium. Many enterprises looking to advertise online will be much more willing to seek ad space on much more frequented (in terms of number of hits and time spent on the site) than Pandora: i.e. Facebook, Google, Yahoo!, and MSN.
Likewise, as more large corporations currently comprise the bulk of mobile ad spending, small and medium sized entities are still years away from spending a substantial portion of their ad dollars on the mobile space. Having the ability to cater to smaller businesses would enable Pandora to charge more for the service, as the ads would be more targeted to its local constituents than a generic ad that large corporations currently deploy. It will take a substantial amount of time before Pandora can round off its advertising portfolio with more value added services.
- Pandora has yet to Become a Destination Site
Yes, the site does attract nearly 50 million visitors per month, but how many of these people simply activate the service and go about other activities? Many of the users listen to Pandora at work, while doing chores around the house, or while driving (feeding the stream through Bluetooth to the auto’s radio).
The website has attempted to diversify its offering by adding artist biographies, song lyrics, a music feed that tracks what others are listening to, and a user profile page. Do the eyes of users of Pandora’s service have the same value as the same eyes on other destination-like websites (Facebook, say)? No. Destination sites like Facebook have multiple routes towards captivating a given user – through tools that allow users to converse with friends/family, through the presentation of videos/pictures, and through the offering of online social games like those presented by Zynga. Pandora has several portions of its site devoted to different banner and block advertisements, but how attractive are these to potential advertisers? Will they get an equivalent number of impressions as will the same ads on Facebook? Pandora spots undoubtedly cost less, but with limited dollars being spent online as it is, most advertisers will likely choose a site with a higher level of more engaged users. The same holds true for the song-interrupting voice ads – increasing the number of these presented per hour will only act to dilute Pandora’s service and turn off users.
- Pandora is Playing a Waiting Game
The corporation’s monthly user base is ever increasing, but so are its huge variable costs in the way of music royalty expenses. Pandora was able to change its royalty structure in the past, when, in 2009, it negotiated deal with SoundExchange – a large licensing negotiator that represents record companies – to cut minimum per-stream royalties by as much as 40%. The corporation’s deal with the music licenser expires in 2015, when it hopes to once again restructure the deal.
However, until that time (even a favorable restructuring is not certain), Pandora will likely lose money on each transaction. With royalty expenses increasing just as fast (if not faster) than revenue, the business model will not be extremely scalable for the next several years. To continue to grow ad revenues at a lightning pace also means to drastically increase the corporation’s sales force, which requires more costs (hopefully variable commissions and not fixed salaries).
- Meanwhile, Competition is Knocking at Pandora’s Door
The corporation, which made online radio service attractive to millions, has also indirectly advertised the industry’s ability to generate substantial revenue streams for new entrants. Although Pandora currently controls around 5.5% of the total U.S. radio market (quite impressive), there is no guessing what might happen over the next several years as the corporation still struggles to generate a profit. Several new competitors have already entered the field, including the newly popular Spofity, as well as Clear Channel’s iHeartRadio app.
Likewise, although they do not present online radio services, per say, extremely well funded and much larger corporations like Apple, Amazon.com (NASDAQ: AMZN) and Google have already developed their own platforms in cloud music. iCloud, Cloud Drive, and Google Play all allow users to tap into music they already own, whether on their work computers, their mobile phones, or their tablets. For every current user of Pandora, there is a very likely chance that another user will migrate to one of the many new online music listening/sharing services that are destined to pop up in the next several years.
Yes, the AT&T data plan change announcement is the least of Pandora’s worries.
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