What Tones Have Investors Heard About Pandora?

By Jay Wei - July 2, 2012 | Tickers: AMZN, AAPL, P, SIRI | 0 Comments

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For music lovers, Pandora (NYSE: P) has sounded a distinct pitch with its leading Internet radio’s music-streaming service. I had always wanted a radio station that would be dedicated to playing selected opera arias, and somehow to my taste. But there wasn’t really anything like that before Pandora. Sirius XM (NASDAQ: SIRI) had an opera station that would play only the Metropolitan Opera’s productions in full length and was entirely one-way programming. That didn’t really satisfy my craving for classical vocal. Now using Pandora, anyone with any musical preference can create his own radio stations, and the music can be better tailored to individual tastes over time based on listeners' feedbacks.

But granted, Pandora doesn’t deliver music on demand. This means that Pandora cannot and will not play solely a particular artist of a listener’s choice on a single station, nor can it play the same artist too frequently during a certain time period to have the music streaming considered an interactive service. Interactive, or on-demand, music streaming services pay royalties at higher rates and often are designed to work with paid subscriptions or download purchases, such as those offered by Rhopsody, Amazon (NASDAQ: AMZN) and Apple (NASDAQ: AAPL)’s iTunes Music Store. Non-interactive music streaming services in the U.S., including that offered by Pandora, operate under federal legislative statutes that subject providers to much lower loyalty rates. For 2012, the rate that Pandora pays is $0.0011 per performance. Non-interactive streaming also doesn’t have to obtain direct licensing rights from records owners. This way, users of non-interactive music streaming often enjoy free listening time or receive enhanced services for only a minimal subscription fee.

The trade-off from using non-interactive music streaming is that users won’t be able to hear works solely from their chosen artists or composers, but instead a lot of additional music content from other similar artists or composers. Pandora relies on its so-called music genome project, a music selecting regime, to find songs that it deems to be comparable in musical taste to a listener’s original choice. I’ve tried many of the non-interactive music streaming services out there, such as iheartradio and Slacker Personal Radio. By comparison, Pandora easily makes my choice for its ease of use, sound quality, smooth page loading and most importantly, its effective sound selecting methodology. With some of the other services, a soprano station may later give you a tenor performance, and an opera station may even play a pop song suddenly. My Pandora experience so far has been a satisfying one. No wonder Pandora has the most registered users of over 125 million and also the largest active-user base of 47 million, as of January 31, 2012.

It is true that Pandora will incur more costs as it grows its user base and plays more songs. But isn’t it also true that any business would have to spend more if they want to make more products or provide more services in order to increase revenue and profit? For Pandora, attracting more users and subsequently paying more on increased playing requests is its only cost of doing business. This will help it sell more ads to generate more revenue, and eventually turn its current loss into a profit. It’s hard not to agree that a user base of 100 million likely has attracted more advertisers than a user base of 10 million.

I don’t think it is a losing proposition that the more listeners Pandora has, the more it pays for music streaming. This is just how Pandora expands its business to generate more ad revenue. No business growth is cost free. If a company is not willing to spend more in order to produce more, how can it make more sales and profits? For Pandora, the more music it streams, the more audio ads, for example, it can place in between songs it plays.

Thanks to its user growth and streaming increase, Pandora has been generating more ad revenue and narrowing its losses, and is expected to continue to do so. In the fiscal first quarter of 2012, revenue rose 58 percent to $80.8 million with a loss of 12 cents a share, compared to a loss of 61 cents a share a year earlier. The company forecasts second-quarter revenue of $99 million to $101 million and a per-share loss of 3 cents to 5 cents, excluding special items. With growth of ad revenue eventually outpacing increase in streaming cost, Pandora can break even and then show a profit.

In fairness, investors need to hear how Pandora’s streaming performance is playing out and at what cost. But that shouldn’t become a noise to overshadow the tone that the company has stricken for its ad revenue growth. As long as ad revenue can make up for streaming cost, investors will be handed their share of profits.

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