Pandora (P) is a wildly successful streaming music company. It has the biggest audience of any similar service, with more than 76 million people tuning in as of Q2. According to Pandora, that accounts for more than 8% of the entire radio listening market!
But as with so many tech stocks, Pandora was able to post impressive growth in its early days and is starting to see that growth slow. In Q2, active Pandora listeners were up just 7.5% year-over-year.
While listener hours were up by much more than that, with about 29% growth, it is important to note that if Pandora stops growing the number of people who subscribe, it will have a very difficult road ahead.
And in the bigger picture, poor user growth could only be the beginning of the challenges revealed to Pandora stock investors in the next earnings report.
Pandora Earnings Preview — Growth Struggles on All Fronts
The user growth metrics at Pandora are fairly straightforward. But a sense of urgency is there for Pandora stock investors to see improvement, because so many other data points are under pressure.
Take margins, driven in large part by the royalties that Pandora pays on the songs it plays. Recently, an organization called SoundExchange pitched a higher royalty rate for streaming radio services like Pandora, effective in 2016.
On the surface, the move is negligible — SoundExchange wants Pandora to pay 0.25 cents per song in 2016, which bumps up to 0.29 cents by 2019. However, when you do the math that works out to well more than half gross revenues.
Advertising, particularly on any internet-dependent property, has never been a high-margin business. And this just puts more pressure on Pandora.
Furthermore, the only way to grow in such an environment is to rapidly increase scale if you can’t increase margins — and as mentioned, user growth is slowing. That leaves two metrics that Pandora can push on: the number of hours each existing subscriber uses the service, or Pandora One premium accounts.
The problem with Pandora One is that the service removes all ads from the experience — therefore, “super users” who pay the premium price of $4.99 per month may not result in much profit (if any) should they listen to a boatload of more music.
That leaves only the core metric of listener hours as one to push on.
Admittedly, that measure grew briskly last quarter. But let’s not forget that Pandora isn’t operating at a profit — unless, of course, you go in for that wonderful non-GAAP accounting that Silicon Valley loves so much.
Also, we haven’t even mentioned the idea of competition via Spotify or Apple (AAPL) with its iTunes Radio streaming service….
If you think Pandora can keep convincing folks to listen more (and serve more ads as a result), then go ahead and buy Pandora before earnings.
But the fact that P stock is down 24% in the last month or so should signal that Wall Street is quite skeptical of this streaming radio company’s upcoming performance.
I say sit back, listen in and wait for improvement in the numbers before messing with Pandora stock.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.
