Pandora Should Consider Becoming A Virtual Mobile Network Operator

Given that all the indicators show that growth slowing, Pandora will have to move horizontally to survive

Current Financial Condition

In spite of achieving consistent growth in users, revenues and practically all other operating metrics since its launch in 2005, Pandora has never made a profit. There are three main reasons for this:

  • Crippling royalties which cost the company about 57% of revenues
  • Mobile ad revenue per listening hour is half that of online
  • The percentage of paying subscribers is stuck at a few percent

Crippling royalties

For every dollar of revenue Pandora earns it must pay 57 cents to the music industry, which is the average royalty payout over the last 4 quarters.

Because Pandora derives about 80% of its revenue from advertising we can, to a first order, regard the company as having a similar business model to that of Facebook, Google and other digital ad platforms and ad networks.

But if it had to hand over 57% of its ad revenues to external parties then even Google would swing from being fantastically profitable to terminally loss-making.

Mobile ad revenue per listening hour is half that of online

Pandora derives 70% of its revenue from mobile devices but the company’s financials show that the average advertising revenue earned per mobile listening hour is about half that for a non-mobile listening hour. 

This is a fundamental feature of the mobile advertising market and all players – including Facebook and Google – are dealing with the same problem.

In Q109 just 14% of Pandora’s total listening hours were to mobile devices. But by Q114 this had climbed to 80%. Although the rate of increase is now slowing down, the effect of this trend is to reduce the average advertising revenue per listening hour as the company grows.

The percentage of paying subscribers is stuck at a few percent

In spite of managing to increase the number of paying subscribers over the last 4 years, most users still prefer the free, ad-funded version of Pandora: we estimate that the average number of paying users over the 2010 to 2013 period is:

  • 2010: Average of 0.1m paying subscribers representing 1.0% of the active user base
  • 2011: Average of 0.4m paying subscribers representing 1.9% of the active user base
  • 2012: Average of 0.8m paying subscribers representing 2.1% of the active user base
  • 2013: Average of 1.2m paying subscribers representing 2.2% of the active user base

So while the total active user base continues to grow the percentage of those users who pay is stuck at a few percent.

A possible solution:  Virtual mobile network operator (MVNO)

It is hard to see how Pandora can simply ‘execute’ its way out of its current financial predicament. Plainly, the company’s’ current strategy is not delivering the profits that investors will demand at some point.

While Pandora has done an excellent job in achieving growth it has failed to produce profits – and that is after 8 years. Not only that, with the numbers as they are even when the company stops spending to expand its user base, then Pandora will still be unprofitable.

This suggests that a major change of strategy is needed or, more exactly, that Pandora needs to develop a strategy that can be overlaid on top of the company’s existing music-focussed model which is very popular, with 75 million active users.

Based on the fact that Pandora’s active user base is very loyal and also that 80% of listening hours are mobile then we think it would be logical for Pandora to think in terms of launching a mobile service – which the company could market to a loyal, mobile-focussed user base comprising about 80% x 75 million = 60 million individuals.

This would represent an inversion of the strategy that has already been proven in the music subscription service market where, for example, Deezer and Spotify have approached mobile network operators who then bundle their music service into an existing service plan. 

So instead of a mobile network operator reselling Pandora’s music service, we are suggesting that Pandora resells a mobile network operator’s service.

Pandora would need to approach a major US wireless carrier who operates a virtual network operator programme such as, for instance, Verizon Wireless.

Under this model, Pandora would develop and launch a Pandora-branded mobile service. The capital costs for this would be relatively modest (Pandora would piggy back off an existing network) and would mainly involve building the billing and customer service infrastructure needed to deliver the service. Alternatively, Pandora may be able to speed up the process by buying those assets via the acquisition of a smaller U.S. wireless player.

We think that a service-only plan could be interesting, assuming that this could be negotiated with the network partner: users would be able to insert a ‘Pandora’ SIM into their existing device in order to obtain access to the service, which would be focussed on a simple plan that included data and voice.

Users would be able to retain their existing smartphone and all their apps.

If we assume that Pandora was able to sell this service to 5% of its addressable user base then this would be 5% x 60 million = 3 million users.

If we further assume that the average service charges for the service would be USD 30 a month, and that Pandora received half of this (the other half being paid the network partner), then this would represent an annual revenue of 3 million x 12 x USD 15 = USD 540 million – which is more than 2x the company’s current revenues.

If the mobile service was competitive enough in its own right then it would be likely to be interesting some of the additional 120 million users who have registered with Pandora but who are not active users.

To be clear, a Pandora ‘mobile service’ would serve a niche market: as of December 31 2013, AT&T wireless served more than 110 million wireless subscribers across the U.S. So even if Pandora was fantastically successful with an MVNO approach its total subscriber base, at let’s say just 3 million, would still be a tiny percentage of the total U.S. wireless market. 

Nevertheless, in spite of being a small player in the overall wireless market, the gross margin that could be harvested by this strategy would be enough to convert Pandora from a fundamentally loss-making business into a profitable company.

Following last year’s public offering, Pandora currently has over USD 440 million of cash in the bank and market sentiment towards the company is strongly positive. Therefore, we think that now is a good time for Pandora to be bold.