Pandora Media Inc. A Solid Buy Going Into Earnings

Pandora Media (NYSE:P) remains one of my better performing contrarian ideas, and I continue to reiterate my stance on the company despite weakness in near-term margins and fundamentals. Furthermore, the company seems better positioned to sustain a healthy revenue CAGR, as data points imply significant market share gains among ad agency spending. Since Pandora and Spotify are the only major only radio streaming applications, the data points suggest that Pandora will at least reach its targeted revenue growth assumption for the upcoming quarter.

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Source: UBS Research

In the month of January, Pure Play internet radio grew by 33.3%, but then in the month of February the same figure accelerated to 62.9%. There’s no data on the month of March yet, but you’re getting a solid picture of implied growth comparisons to the prior year. The current consensus estimate is $1.41 billion revenue or roughly 21.5% y/y revenue growth for FY’16. Therefore, the early data points from agency ad spend implies reduced expectation risk going into the next quarters. Analysts anticipate revenue of $286.38 million for Q1’16, which seems attainable given the preliminary data on ad agencies and the lack of estimate revisions from the sell side going into the upcoming earnings report.

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Here’s the most recent commentary from Michael Pachter over at Wedbush Securities:

We expect Pandora results in line with its preannouncement. We expect revenue of $290 million, Adjusted EBITDA of $(65) million, and EPS of $(0.32), vs. consensus of $286 million, $(68) million, and $(0.32), respectively. This compares with Pandora’s updated expectations for Q1:16 non-GAAP guidance to be at the high-end of the revenue range of $280 – 290 million and adjusted EBITDA range of $(75) – (65) million.

Wedbush sits slightly above the consensus in terms of revenue and is at the low-end of the range when pertaining to adjusted EBITDA losses. Clearly, if revenue is at the top-end of the outlook range, the margins will also be at the top-end. This is because Pandora’s LPMs (licensing cost per thousand hour) is fixed at $32 with some adjustments to inflation. However, advertising revenue per thousand hours of listening (RPM) was $57.20 in the prior quarter, so if RPM increases above expectations, the company’s adjusted EBITDA margin will likely outperform, as much of the cost structure is already fixed at a specified level.

Now, the growth in ad-agency spending was partially owed to Pandora’s rapid expansion of marketing spend as it comprised 30% of revenue in FY’15 versus 26% in FY’14. The incremental spending on app installs drove better ad-inventory as more listeners equates to more listener hours. Pandora has also been executing on the back-end advertising infrastructure. In an effort to compete with terrestrial radio advertising, the company has developed better targeting, so ad agencies can compare the pricing/demographics with terrestrial radio.

The improvement to back-end monetization is the real catalyst to the stock and not the product specific features. It’s been well known that Pandora does a better job of curating songs on its platforms when compared to competitors. A linear concept to radio still works, especially when you have live DJs in the studio spouting the usual nonsense we expect from traditional radio programming. In other words, the devil is in the detail and right now Pandora has the best experience for digital radio when compared to Spotify.

Some have even gone so far as to label others as ignorant or unable to comprehend the Pandora story. For example, Rocco Pendola over at Seeking Alpha snipes at other analysts for “not understanding” the story. But, from what I’ve seen, the vast majority of analysts comprehend what’s going on with the company, and many have already placed price targets that are roughly 40% higher than its current valuation. Obviously, Pandora’s biggest issue coming out of 2015 was the music licensing agreement, which costed shareholders a lot more than what initial estimates implied. The Radio Music Licensing Committee secured the best possible deal for music artists/labels, but at the same time made it difficult for smaller music applications to compete due to the heightened content acquisition cost.

However, it’s Pandora’s back-end advertising model that’s leaps and bounds ahead of the competition. So, even with these heightened costs the company stands a reasonable chance of beating on both margins and revenue in the current fiscal year. Furthermore, the competition has thinned and many will not transition very successfully to pure play radio. So, when you combine diminishing competition with greater economies of scale you begin to wonder if Pandora is best positioned to corner digital pure-play radio. Pandora has also built further product synergies into the app by providing conventional radio, on-demand music streaming and event promotion. In other words, Pandora is a great ecosystem play but also has promising monetization aspects that differentiate it from other mobile applications.

Also, some commentators are now re-introducing the topic of an acquisition from some of the bigger tech players. But why? If anything, it’s not the investment bank analysts or the buy side analysts that are clueless. The mainstream media is looking to hype their stance with nonsensical commentary not pertaining to the core business model or purport their bullish hypothesis via unsubstantiated M&A dialogue. In other words, the M&A hypothesis doesn’t really make any sense (given the lack of cost/product synergies) nor should it be a significant reason to form an investment thesis for the company.

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Source: Freestockcharts

The investor base has already acclimated to weak commentary on margins, so the expectation risk has been de-risked quite significantly. If anything, the management team may have intentionally set the bar low with its full-year outlook, so they can produce a series of earnings beats to drive the stock price higher. I suggest reading my prior Pandora commentary to understand the various revenue/cost drivers prior to the earnings announcement. There’s a really sound fundamental case for investing into the stock as it’s not just another “story driven narrative.”

Despite the recent momentum in the stock, I believe there’s further upside left in the tank. As such, I continue to reiterate my high conviction buy recommendation and $11.97 price target. I haven’t adjusted my model quite yet, but will plan on adjusting my estimates following the earnings report on April 28^th.