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Should Apple Acquire Pandora?

Posted on Friday, Nov 6th 2015

According to a study by Edison Research and Triton Digital, Pandora is still the leading Internet-only audio service with 54% share followed by iHeartRadio (11%), Spotify (10%), and iTunes Radio (8%). However, what is killing Pandora is its rising content acquisition costs and an unsustainable business model coupled with increasing competition. Its value has dropped considerably, which might make it an attractive prospect for Apple.

Pandora’s Financials
On the face of it, Pandora (NYSE: P) had a reasonably good quarter. Third quarter revenue grew 30% to $311.6 million. Analysts estimated revenue of $313 million. Non GAAP net income was $22.9 million and adjusted EBITDA was $30.6 million.

Advertising revenue grew 31% to $254.7 million, or about 82% of its revenue. Subscription and other revenue grew 26% to $56.9 million. Total listener hours grew 3% to 5.14 billion while active listeners grew 2% to 78.1 million.

Total revenues per thousand listener hours (RPMs) reached a record high of $60.52 during the quarter, a $12.52 increase year-over-year. Ad RPMs were also up 28% year-over-year to a record $56.84. This indicates a higher monetization success with the sale of their premium advertising units driven by growth in local advertising spend.  Local ad revenue grew 52% and represented 25% of total ad revenue.

However, total licensing costs per thousand listener hours (LPM) were $41.06, up by $18.76 or 58% over the year. Total LPM increased 10% year-over-year, excluding one-time cumulative charges, to $24.62.

Pandora also reached a $90 million settlement with the major record labels on royalties for songs from before 1972. It also incurred a $23.9 million charge for song-writing royalties. One of its major costs will be decided next month when the Copyright Royalty Board sets recording royalty rates for the next five years.

For the fourth quarter, revenue is expected to be in the range of $325 million to $330 million and adjusted EBITDA is expected to be in the range of $25 million to $30 million. For the full year, Pandora lowered its guidance and revenue is now expected to be in the range of $1.153 billion to $1.158 billion or a mid-point growth of 27%. Adjusted EBITDA is expected to be in the range of $51 million to $56 million.

Pandora’s Business Model Should Change
Pandora’s growth rates pale in comparison to the 50%-100% growth rates it had achieved in 2012. Even though Pandora managed to increase its RPMs, its rising licensing costs have proved more detrimental than increasing competition.

I have always maintained that Pandora’s business model is unsustainable and that it should rethink it. One good move was its strategy to tie up with car makers. Another attempt at diversifying is its recent $450 million acquisition of live events technology company Ticketfly. Pandora hopes to leverage Ticketfly’s data analytics to connect its user base to live events and increase ticket sales. Currently about 40% of tickets are left unsold at mid-market concerts. However, tickets are also a low margin business, so only time will tell how this bet plays out for Pandora.

Investors are not pleased with the lack of a profitable business model and its stock is trading at $12.45, close to its 52-week low of $11.38. Market cap is around $2.66 billion.

Spotify also not profitable
Even Sweden-based Spotify has not had much luck with a profitable business model. It has over 75 million users in 58 markets, of which 20 million are paying subscribers. However, since its inception in 2008, it has paid $3 billion in royalties. Its revenue increased 45% in 2014 to $1.3 billion. However, losses almost tripled, from $68 million in 2013 to $197 million in 2014. But unlike Pandora, Spotify has a subscription-based business with 85% of its revenues coming from subscriptions and only 15% coming from advertisements.

Spotify has been venture funded so far with $1.1 billion in investments. Its last round of funding was held earlier this year when it raised $526 million at a valuation of $8.5 billion.

The music streaming industry has lately seen the foray of tech giants. Apple launched its streaming service Apple Music this year and currently has 15 million users of which 6.5 million are paying users. Google’s YouTube also recently introduced a subscription plan for ad-free music and video.

While Google and Apple can absorb losses from their music streaming business in the hope of creating demand for mobile devices or proprietary music, smaller players like Pandora and Spotify need to either find a more profitable business model to survive or exit in the arms of the bigger giants. With Google upping its YouTube focus, Apple might want to acquire Pandora to increase its user base in the US. At a market cap of $2.5 billion, Pandora is much more attractive than Spotify, which is valued at $8.5 billion.

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