It 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.
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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