A Few Overlooked Facts Prove Pandora is Ready for the Big Time

I've been waiting for Pandora (NYS: P) to show me the money. The leading online music service has this nerve-wracking habit of spending more cash than it earns, mostly because its advertising sales can't keep up with rising content royalty costs.

Last night's second-quarter report may have been the first step of a long journey to profitability. The writing on the wall is clear enough that I'll take a CAPScall action on the news. Read on for all the juicy details.

Pandora was expected to present a $0.03 non-GAAP loss per share on sales of about $101 million. The company met the Street target on the top line, and beat bottom-line estimates with a break-even performance. Positive free cash flows are a rarity for this company, but operating cash exceeded capital expenses by about $100,000 this time. Some will call these numbers the reason behind Pandora's 18% overnight share price boost, but that's far from the whole story.


No, the real meat in this report is that Pandora's ad sales are picking up steam -- particularly in the atrociously unprofitable mobile segment.

A year ago, your mobile Pandora display rarely showed anything but that ubiquitous cupcake ad from LivingSocial -- itself an underdog in a failing industry. Hardly the best of all possible ad-space sales situations. Now, you're likely to run into banners, audio spots, and even video ads from national retailers, large banks, and car manufacturers -- with a healthy sprinkling of local fare not wrapped in LivingSocial coupons.

I find it particularly comforting that the efficient and very respectable mega-bank Wells Fargo (NYS: WFC) sees a reasonable return on investment in Pandora ads. Wells Fargo places a lot of ads on Pandora's mobile platform. This bank does its homework, and cares about high-quality investments. If Pandora is good enough for Wells Fargo, it should be good enough for many other national brands, as well. Bring in leaders like this, and others will follow. That virtuous cycle should boost ad rates for years to come.

This much healthier ad mix is showing up in Pandora's results. Mobile ad revenue per thousand impressions, or RPM in industry lingo, increased 8.6% year over year, to $21.5. That's still a far cry from the $54 RPM that advertisers are paying for Pandora's browser-based ad space on traditional desktop computers, but it's a move in the right direction. Mobile use already accounts for 75% of Pandora's listening hours, and the desktop client's share is only shrinking.

Will the elections matter?
CEO Joe Kennedy tipped his hat to political ads as a modest revenue driver in the coming quarters. Campaign ads were a "very modest" component of the second quarter's results, but Pandora's demographic and geographic targeting should make it a popular platform as November draws closer. "Most of our ad spending will take place in these final months here leading up to the election," Kennedy said, while also warning that TV spots still suck up the vast majority of political ad spending.

This view is underscored by the fact that online ad leader Google didn't mention the elections at all in its July report, while TV maven CBS hung its autumn hat squarely on that peg. The carpet-bombing methodology of TV ads does seem like a good fit for politicians trying to reinforce their public image across the board. Sniper-style online ads could work, one political issue at a time. For better or worse, that's just not how our elected leaders roll.

Time to take action
Pandora has done exactly what I asked it to do, which is to show me that its ad sales strategy is on the right track. Therefore, I'm removing my thumbs-down CAPScall on the stock, because I don't think the company will crash and burn anymore. In Foolish parlance, that's comparable to upgrading Pandora from a "sell" to a "hold." We take these CAPScalls very seriously.

But I'm not turning my frown entirely upside-down either. It's a long way to the top if you wanna rock and roll. Give me another quarter of roughly break-even cash flows and rising mobile ad rates, and we'll talk CAPScalls again, okay?

Want to know why Well's Fargo's stamp of approval was such a key validator for me in assessing Pandora's earnings?  Read this free report if you wonder why I'm so impressed by Wells Fargo's ad placements. This bank is so on top of the ball that our analysts call it The Only Big Bank Built to Last.

The article A Few Overlooked Facts Prove Pandora is Ready for the Big Time originally appeared on Fool.com.

Fool contributor Anders Bylund owns shares in Google, but holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Wells Fargo. Motley Fool newsletter services have recommended buying shares of Google and Wells Fargo. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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