Pandora Says 40-Hour Mobile Cap Cuts Music Content Costs

Pandora Media Inc., the biggest online radio service, said a 40-hour monthly limit on mobile users imposed earlier this year has cut music streaming and content costs as intended, while the audience continued to grow.

Pandora streamed 1.31 billion hours of songs in April, the first full month with the cap in place, a 5.1 percent drop from February’s 1.38 billion, the Oakland, California-based company said yesterday in an e-mailed statement. Adjusting for February’s fewer days, listeners streamed 10 percent less, Chief Executive Officer Joe Kennedy said in an interview.

“The decline in hours will be very closely mirrored in content acquisition costs,” Kennedy said, declining to provide specifics. The company reports fiscal 2014 first-quarter results on May 23.

Pandora’s results since implementing the cap suggest the company is starting to contain content costs, its biggest expense, without alienating listeners. With fewer hours of use, investors are concerned that the company is also sacrificing advertising revenue, said Michael Pachter, an analyst with Wedbush Securities Inc. in Los Angeles.

“The hours are down sequentially,” said Pachter, who has a neutral rating on the shares. “A lot of that has to do with the mobile cap, which chased away some abusive users, but the company will still have some explaining to do.”

Pandora fell 4.1 percent to $14.08 at 2:46 p.m. in New York after declining 6 percent, the biggest intraday drop in about a month. Before today, the stock had climbed 60 percent this year, outperforming the 14 percent gain in the Russell 1000 Index.

Mobile Users

The company in March began targeting the 4 percent of mobile users who were streaming more than 40 hours monthly, to stanch royalty payments that had ballooned as the service gained popularity.

Those who reach the cap can pay 99 cents to continue using Pandora, switch to a desktop computer or enroll in Pandora One, a $36-a-year commercial-free option that gives more control over song selection.

Of the users who hit the limit in March, 86 percent returned in April, Kennedy said. Some coped by switching to Pandora’s unlimited desktop version, while others chose to pay, Kennedy said. He declined to provide specifics.

Coping Methods

“People found a way to make it work for them,” said Kennedy, who resigned as chairman and CEO in March, pending the selection of a successor. “The vast majority found one or a combo of those methods worked for them.”

Some went to competitors, Jim Cady, chief executive officer of smaller rival Slacker Inc., said today in an interview. The San Diego-based company redesigned its service in February and ran a marketing campaign aimed at Pandora users, he said. He declined to disclose market-share figures.

“We’re seeing surges in new listeners coming in toward the end of the month and that started in March,” Cady said. “Every new listener, whether free or paid, mobile or web is profitable for us. We don’t have any interest in capping people.”

Pandora’s active users in April climbed to 70.1 million, the company said in the statement. That represents about a 3.5 percent increase from February’s 67.7 million and a gain of 0.9 percent from March. Pandora’s share of total U.S. radio listening declined to 7.3 percent from 8.5 percent in February and 8.1 percent in March.

Since April 2012, Pandora’s active users increased 35 percent, the company said. Listener hours climbed 24 percent and radio share rose from 5.95 percent.

Cost Impact

“We are getting what we wanted,” Kennedy said. “We’re seeing continued growth in subscribers and an impact on a small percentage of users that’s having a significant effect on content costs.”

The company said in March it is targeting a reduction of its content spending to 40 percent of revenue over the next few years from the current 60 percent.

Content costs for the fiscal year ending in January 2014 will rise 49 percent to $386.5 million from a year earlier, Scott Devitt, an analyst with Morgan Stanley in New York, estimated in an April 18 report. He projects revenue will rise 49 percent as well, to $635.1 million.

Mobile users are more costly for Pandora because some of the ad inventory goes unfilled, cutting into revenue while music royalties add up.

“The incremental revenue from the 41st hour of listening isn’t really something that offsets that additional content cost,” Kennedy said.

As with most companies that report little profit, Pandora trades on revenue, Wedbush’s Pachter said. There is little room for mistakes, he said.

“Those investors expect perfection,” Wedbush said. “They’re looking for perfection.”

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