Why Pandora Will Never Be Great Again

Pandora RadioIt isn't easy making a living streaming music to freeloaders these days.

Shares of Pandora Media (P) took a hit on Wednesday after the leading online music service provider posted alarming guidance for the new quarter.

The company's fiscal third quarter wasn't a problem. Revenue soared 60 percent to $120 million, and the pioneer in Web-based music discovery managed to squeeze out a small profit on an adjusted basis.

Pandora's popularity is unquestionable. The company served up 3.56 billion listener hours during the quarter, 67 percent more than it did during the prior year's third quarter. Active users have soared 47 percent in the past year to 59.2 million.

There are plenty of reasons to fear that the growth won't continue, and we'll get to that in a moment. First let's tackle the outlook that sent the shares spiraling lower.

Panned Aura

The holiday quarter won't be very festive for the former dot-com darling. Pandora is targeting a deficit of $0.06 a share to $0.09 a share. Analysts were holding out for a modest profit. Pandora is forecasting $120 million to $123 million in revenue, well short of the $130.3 million that Wall Street was expecting.

This is bad, folks. At the low end of its range, Pandora is saying that sequential revenue growth will be flat with the $120 million it just posted in its fiscal third quarter.

There shouldn't be a lot of seasonality in Pandora's metrics, so the flat sequential growth and the sharp loss are very disappointing. And it can get worse.

Everybody Wants Your Ears

Pandora is the undisputed champ of online music streaming, but it may not keep the crown.
Satellite radio provider Sirius XM (SIRI) plans to add a Pandora-like component to its streaming platform later this month. Reports have been surfacing for weeks that Apple (AAPL) is in licensing talks with the major record labels to introduce its own streaming service early next year.

Microsoft (MSFT) is already in the game. It introduced its Xbox Music service several weeks ago, and a component of the offering is a Pandora-like platform that suggests related music tracks. Spotify -- the overseas speedster that launched stateside last year -- also recently took a page out of the Pandora playbook by enhancing its flagship play list service with music discovery of its own.

The loyalty of Pandora's user base will be tested, and the company may flunk out.

Where's the Loyalty?

Pandora, sadly, is a bastion of freeloaders. Just $13.7 million of its revenue in its latest quarter came from paying subscribers. When premium subscriptions account for just 11 percent of your revenue -- leaving you at the mercy of online advertising -- there's going to be a loyalty problem.

Pandora's CEO spoke before Congress last week, arguing in favor of the Internet Radio Fairness Act that would lower the royalty rates that it's currently shelling out to artists and their record labels. A whopping $182.1 million of the $266.2 million in revenue that Pandora has generated through the first nine months of the year -- or 68 percent -- went right back out in content acquisition costs.

As Sirius XM, Spotify, and likely Apple rally users around their premium offerings, Pandora's having a hard time coping with royalty rates that amount to fractional pennies for every track that's streamed.

Pandora's biggest growth is coming from mobile users, more than doubling to $73.9 million in its latest quarter. Investors normally get excited about mobile monetization, but handset makers and wireless carriers are starting to see music as a way to gain new smartphone customers. Nokia (NOK) offers Nokia Music on some devices, giving owners the ability to stream unlimited music for free.

The holiday quarter is going to be bad, but the future may get even worse for a company with a flawed model just as savvier competition is about to begin body surfing in the crowd.

Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Microsoft and Apple. Motley Fool newsletter services have recommended buying shares of Apple, creating a bull call spread position in Apple and creating a synthetic covered call position in Microsoft.

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I love Pandora Radio as it is head and shoulders above IHeart...I heart uses too many cover groups...The amount I pay a Yr is paltry and NO COMMERCIALS....no bad songs ever...and I use it because there is no Classic Rock music in Central Florida....there is a great station in Daytona

December 09 2012 at 6:01 AM Report abuse rate up rate down Reply

i gladly pay, even tho i still feel like i should be able to choose what i want and don't want to hear. that's my biggest problem with pandora. otherwise, it's great.

December 08 2012 at 10:42 PM Report abuse rate up rate down Reply

I pay. It's a paltry sum to listen to only the music I like without the interruption of commercials. I hate FM radio anymore, esp. in the area where I live. They keep playing the same songs that were popular 20 years ago and those stupid morning shows with Dumb and Dumber, good riddance. I stream Pandora all day at home. It's wonderful listening with a pair of wireless speakers where the radio used to sit. Now with all Christmas all the time on the local stations I won't be going insane until Jan 2 either.

December 08 2012 at 8:19 PM Report abuse rate up rate down Reply

I love listening to Pandora and don't have a problem paying a small amount of money for a year to not have to hear the commericals, to me its well worth the money if you truly love music the way I do.

December 08 2012 at 7:36 PM Report abuse -1 rate up rate down Reply

Hopefully they can ink a deal with Verizon or AT&T to share the load. To be honest i don't find the ads very intrusive at all. I understand u have to have them for this service to be free. Maybe a small fee on my Verizon or AT&T bill for the Pandora option wouldn't be a bad idea. Ad-free of course.

December 08 2012 at 2:25 PM Report abuse rate up rate down Reply

Pandora is amazing. I can't believe it has been free for this long! I will remain loyal to Pandora as long as it retains its quality of service. If they start charging or doing something else to lessen the current quality and value I receive, I will simply use another provider such as I Heart Radio, etc.

December 08 2012 at 10:29 AM Report abuse rate up rate down Reply

I like Pandora. I love Spotify.

December 08 2012 at 8:47 AM Report abuse rate up rate down Reply

I can tell you why in just three words , , , I HEART RADIO , , I had a bunch of Music apps on my phone ,
but when I got I H R , ,I took off all the other apps and now that's all I use . .I love it with the ease of use
and mega selections of stations to choose from and different formats of music, news and talk radio .

December 08 2012 at 6:43 AM Report abuse rate up rate down Reply

I think the author of this article is missing an important point about Pandora. Its not just about online streaming of music. There are many free online music streams. What makes Pandora different is the ability for the listeners to program their own station, so that they hear only the kind of music they want, rather than having music programming dictated to them by advertisers, and pay subscribers also get their music ad free, and that in itself is worth paying for if you hate endless ad interuptuions. Pandora should go all pay, its worth it.

December 07 2012 at 2:14 PM Report abuse rate up rate down Reply

I wish I had unlimited skips with the basic service. Other than that it's great!

December 07 2012 at 12:50 PM Report abuse +1 rate up rate down Reply