Friday, July 22, 2011
Pandora has a Broken Business Model
Pandora (P) just listed. Nice product for music discovery, where they attempt to put together a custom music station based on a seed song and continuing feedback from the user. They stream the content over the internet to various connected devices.
They have not been profitable, but a quick look at their numbers makes it appear that they are on the cusp of profitability. Unfortunately, there is a problem. Their costs scale with the number of songs they play, but their revenue scales differently, based on their various attempts at advertising. So far it appears that their core costs for revenue are something like 2.1 cents/hour of served music, and have held fairly steady, whereas their revenue/hour of music served has declined from 3.2 cents/hour to 2.7 cents/hour Q/Q, which is quickly approaching their cost level. So, as the hours of music served scales up, their model gets worse and worse.
They know this. That is probably why they limit "free" users (users subject to advertising) to 40 hours/month, or 480 hours/year. They sell an annual service commercial free for $36/year, which together means that their maximum revenue expectation is 7.5 cents/hour, although they have never shown that they can hit that. It's just where they top out.
In their prospectus they spend a lot of time talking about their need for growth of songs served so as to attract advertisers, but at the same time they limit how much they are willing to serve. A bit of a disconnect there. If growth was good, they would not limit it.
Many of their other numbers presented in the prospectus are suspect as well, with some acknowledged as such in some fine print somewhere but others not. For example, they headline 90M accounts in the US. Bald faced misdirection. There are about 330M Americans, so ca. 1 in 4 has a Pandora account? B.S., and they say it's B.S. later. They say they do about 1 minute of audio advertising/hour and give a number for the terrestrial radio industry that is likely much lower than is actually the case. I haven't heard any audio advertising in hours of listening, so they overstate their serve rate and understate the competition's serve rate, making it seem that they are closer together than than they are. Terrestrial radio advertises as much as it does because it has to to remain viable, so misstating that ratio is misleading. At the same time, they talk about their low serve rate as an advantage. Well, yeah, it's nice for users, but not for investors. They don't talk much about their competitor's models. As a quick example, consider Sirius/XM, that has fixed content costs and a subscription model that scales revenue with subscriber numbers. So every new subscriber costs them little and adds a lot of revenue. That's a viable growth model, and is just the opposite of Pandora's.
Unless a miracle happens (advertisers start flocking to them and paying unprecedented rates under their current model, or they change their model somehow) they will have trouble. I think the IPO was a survival bid.
They have not been profitable, but a quick look at their numbers makes it appear that they are on the cusp of profitability. Unfortunately, there is a problem. Their costs scale with the number of songs they play, but their revenue scales differently, based on their various attempts at advertising. So far it appears that their core costs for revenue are something like 2.1 cents/hour of served music, and have held fairly steady, whereas their revenue/hour of music served has declined from 3.2 cents/hour to 2.7 cents/hour Q/Q, which is quickly approaching their cost level. So, as the hours of music served scales up, their model gets worse and worse.
They know this. That is probably why they limit "free" users (users subject to advertising) to 40 hours/month, or 480 hours/year. They sell an annual service commercial free for $36/year, which together means that their maximum revenue expectation is 7.5 cents/hour, although they have never shown that they can hit that. It's just where they top out.
In their prospectus they spend a lot of time talking about their need for growth of songs served so as to attract advertisers, but at the same time they limit how much they are willing to serve. A bit of a disconnect there. If growth was good, they would not limit it.
Many of their other numbers presented in the prospectus are suspect as well, with some acknowledged as such in some fine print somewhere but others not. For example, they headline 90M accounts in the US. Bald faced misdirection. There are about 330M Americans, so ca. 1 in 4 has a Pandora account? B.S., and they say it's B.S. later. They say they do about 1 minute of audio advertising/hour and give a number for the terrestrial radio industry that is likely much lower than is actually the case. I haven't heard any audio advertising in hours of listening, so they overstate their serve rate and understate the competition's serve rate, making it seem that they are closer together than than they are. Terrestrial radio advertises as much as it does because it has to to remain viable, so misstating that ratio is misleading. At the same time, they talk about their low serve rate as an advantage. Well, yeah, it's nice for users, but not for investors. They don't talk much about their competitor's models. As a quick example, consider Sirius/XM, that has fixed content costs and a subscription model that scales revenue with subscriber numbers. So every new subscriber costs them little and adds a lot of revenue. That's a viable growth model, and is just the opposite of Pandora's.
Unless a miracle happens (advertisers start flocking to them and paying unprecedented rates under their current model, or they change their model somehow) they will have trouble. I think the IPO was a survival bid.
Update: confirmation
Also, none of this says anything about how the stock will do in this most manipulated of all markets of the last 30 years.
Disclosure: no holdings as of posting date/time
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8:39 AM
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