- WORLDS APART: In mid November, P disclosed the progress of its Webcaster IV proceedings with SoundExchange regarding music licensing rates starting in 2016. The two sides are world apart, particularly on ad-supported music, where SoundExchange is proposing rates 125% above that proposed by P. We estimate that roughly 90% of P's music is streamed by ad-supported users.
- A COMPROMISE WON'T BE GOOD ENOUGH: We're not suggesting that SoundExchange gets the rates it's proposing. But anything short of the best case scenario for P won't be good enough. P's model can't absorb any more cost, and we expect P will have to cut listener hours to curb content costs in 2016. Once P cuts the chord on those users, it will much tougher to get them back, especially with growing competition for listener hours.
In mid November, P disclosed the progress of its Webcaster IV proceedings with SoundExchange regarding music licensing rates starting in 2016. The two sides are worlds apart.
- Pandora: Greater of 25% of revenue or $0.0011-$0.0013 for ad-supported streams and $0.00215-$0.00240 for Pandora One subscribers.
- SoundExchange: Greater of 55% of revenue, or $0.0025-$0.0029 for all streaming music.
The most glaring difference between the two sides is that SoundExchange is not distinguishing between ad-supported and subscription hours, which is a deviation from the current agreement.
SoundExchange's proposal translates to an increase of roughly 125% in ad-supported licensing rates, which is a major concern given that roughly 90% of P's listener hours are ad-supported.
If SoundExchange's proposed rates were in effect in 2014, we estimate P would have paid out nearly all its YTD revenues in licensing costs (at least 91% under the SoundExchange proposed rates vs. the 52% P actually incurred YTD).
A COMPROMISE WON'T BE GOOD ENOUGH
We're not suggesting that SoundExchange gets the rates they're proposing. But anything short of the best case scenario for P won't be good enough; P can barely support its business model at its current content cost structure.
It is important to note that P has to pay for every song it streams regardless of whether it is monetizing that listener. Management had previously suggested that is monetizing less than 50% of its listener hours, so any material increase in content costs would drain a lot of cash out of the model. While P's relatively low monetization levels suggests a ton of runway for future revenue growth, incremental monetization of those hours will require incremental investment in its salesforce.
Below, we aggregated P's content acquisition costs and sales & marketing expenses (net stock-based comp) into a single expense line (expressed as a percentage of revenue). Whatever leverage P has achieved in content acquisition costs over time has been lost to incremental investment in its salesforce. That essentially means there is no leverage in its model.
So, what are P's options when its largest single expense is facing a considerable rate hike, prior to the company achieving any meaningful operating leverage, or generating consistent positive operating or free cash flow?
The most likely outcome is that P will have to directly cut it content costs, especially since it is monetizing less than half of the associated hours. That likely means implementing listening caps, or exiting certain geographies altogether. Once P cuts the chord on those users, it will much tougher to get them back, especially with growing competition for listener hours.
We are hosting our P Short Best Ideas call this Thursday at 1pm EST. Please let us know if interested in joining the call.
Hesham Shaaban, CFA