Pandora Puts 40-Hour Listening Cap On Ad-Based Mobile Service

In order to battle rising music royalty costs, Pandora Media ( P ) has decided to put a cap on free listening on mobile. Users will now be able to listen up to 40 hours of free music every month and will need to pay 99 cents to continue listening for the remainder of the month. Pandora's growth has been stellar when it comes to revenues and the number of subscribers. However, given that the company has been growing much faster on its mobile platform where currently monetization is low, it needs to address this issue. Higher monetization is needed to offset rising costs. Let's take a brief look at Pandora's monetization on mobile and desktop and how the company intends to tackle this issue in the future (in addition to the recently imposed 40-hour listening cap).

See our complete analysis for Pandora Media

Monetization - Pandora Desktop Vs. Pandora Mobile Vs. Traditional Radio

Traditional broadcast radio monetization currently stands at approximately $73 per 1,000 listener hours. In comparison, Pandora's desktop monetization stood at $57 per 1,000 listener hours in calendar year 2012. Pandora's monetization on its mobile platform stood at around $22 per 1,000 listener hours for the same period.

Clearly there is a gap between current monetization levels for mobile and desktop, and the mobile platform is far off from the levels required to build a sustainable business and offset rising content costs. However, the mobile platform continues to grow rapidly. The mobile monetization rate increased by more than 50% in calendar year 2011, followed by a small increase in 2012. Pandora expects to increase its mobile monetization someday to levels similar to what desktops have today.

Path To Higher Monetization

(1) Higher sell through of mobile inventory

Mobile listener hours have grown tremendously over the past few years, leading to an increase in mobile inventory. Close to 75-80% of the total listener hours now come from the mobile platform for Pandora. However, the company currently does not have a large enough sales force in many regional radio ad markets to sell inventory and establishing this sales force will be key to higher sell-through rates for its ad inventory. Over time, as the mobile listener hours growth slows, Pandora should continue pushing sales of its mobile ad inventory and eventually mobile monetization levels should catch up with current desktop levels.

Radio ad buyers are for the most part indifferent between placing their ads on the mobile or desktop platforms since traditional radio has forever been a mobile platform. Therefore, the company is confident about its ability to improve mobile monetization to sustainable levels in the future.

(2) Long-term potential for increase in ad frequency

Pandora serves about 8 to 12 ads per hour which can consist of 7 to 8 interaction-based display ads and 3 to 4 audio ads. In comparison, traditional radio serves around 13 minutes of advertising each hour or about 25 ad spots with each ~30 seconds in duration. Given that Pandora is monetizing its 8-12 hourly ads on the desktop at a rate of $57 per 1,000 listener hours, it implies that Pandora is monetizing better than traditional radio on a per ad basis.

What this also means is that Pandora has a significant opportunity to increase its hourly ad frequency. We believe that this has the most potential in in-vehicle platforms where users are accustomed to higher ad frequency. The traditional radio market is ~$15+ billion. The in-vehicle market accounts for about 47% of the traditional radio market and thus presents a big, untapped opportunity for Pandora.

Our price estimate for Pandora can be significantly higher if the monetization improvement strategies are successful. You can gauge the impact by modifying the above forecast. We currently forecast overall monetization for Pandora instead of separate forecasts for mobile and desktop.

Our price estimate for Pandora stands at $9.75 , implying a discount of about 25% to the market price.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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