Is Pandora's Price Hike Meaningful?
Pandora Media ( P ) recently raised the monthly price of its Pandora One service by $1 to $4.99, making it the first price revision since the service's launch in 2009. The revised pricing will apply to new subscribers, and the existing monthly subscribers will experience no change at this point. In addition to this, the company is also ending the annual subscription option and will transfer its annual subscribers to a monthly price of $3.99 at their next renewal period. This new discounted price is still higher than what these subscribers were paying earlier ($36 a year or $3 per month). Overall, it appears that the price hike will have moderate impact this year. Subscriber ARPU (average revenue per user) will definitely go up meaningfully next year as most subscribers migrate to the new pricing structure. This move, assuming it doesn't adversely impact future subscriber additions, can lead to an upside of over 10% to our current price estimate.
Our current price estimate for Pandora stands at $24 , implying a discount of about 20% to the market price.
Incremental Profits From Price Hike
The price increase will directly flow down to Pandora's bottom line. Currently the company has about 3.3 million paying subscribers, which represents a small fraction of its overall user base. If the price increase of $1 were to be rolled out to all subscribers immediately, it will result in incremental revenues of close to $40 million. This will lead to cash flows jumping by a similar amount. This is a huge improvement considering that the operating cash flow was negative in 2013, according to our calculations. Going forward, these incremental revenues will see strong growth as we expect Pandora to continue gaining subscribers rapidly. The move comes as the company continues to battle rising royalty costs. Pandora states that its royalty rates have increased by 53% in the last five years and will go up by another 9% in 2015. Raising subscription rates alone will not suffice as 95% of Pandora's users are on free ad-supported service. However, the company hasn't done too bad on that front either.
Improving Ad Monetization Is Key To Battling Increasing Royalty Rates
For the stub period of November and December, Pandora's overall RPM (revenue per 1,000 listener hours) stood at $44.71, which is an all-time high. (A fiscal year-end change from January to December produced the stub.) The figure benefited from seasonal strength due to the exclusion of January results, when ad spending tends to go down. Ad RPM and total RPM for mobile and other connected devices reached $36.38 and $40.14, respectively, again an all-time record. Given that Pandora pays royalty costs to record labels and artists based on the number of songs played and not the revenue earned, any improvement in monetization (revenue per song) is going to add to the margins. The company has been ramping up its sales force to sell more mobile ad inventory slots to advertisers who are directing some ad budget to Pandora because of its local appeal and targeting ability. The additional selling and marketing costs have offset the margin growth to some extent.
The business now seems sustainable as the company expects to generate profits for the full-year 2014 despite expecting some loss in the first quarter. It is a pleasant development, and Pandora could use its cash flows to fund overseas expansion in the longer run.
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