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Takeaway: 1Q15 is shaping us as a mixed bag, but may be P's best print this year. The setup gets progressively worse from here.

KEY POINTS

  1. 1Q15 = MIXED BAG: We’re expecting upside to revenues on light 1Q15 guidance and corresponding consensus estimates.  However, we’re expecting user metrics to disappoint on heightened expectations following P’s accelerating user growth off a depressed comp.  We definitively can’t say what is more important for the stock this quarter, but historically P needs to win on both fronts to appease the street.
  2. SETUP GETS WORSE FROM HERE: After 1Q15, the setup deteriorates through the year.  We suspect revenues could disappoint in 2H with consensus calling for accelerating ad revenue growth through 2015.  Further, as we move through 2015, the prospect for declining users grows, and the overhang from Web IV will intensify. 
  3. WHAT WE’RE KEYING IN ON: Listener Hours. Web IV is all that really matters now, and we expect P will lose the one debate that it can’t on royalty rates (bifurcated structure).  Given the potentially significant increase in rates, the more hours P enter 2016 with, the more bearish we become (as perverse as that sounds).  The situation would be far too sensitive to just apply a simple listener cap, and hope it would suffice (see table below).  P would need to take more drastic steps to reign in content costs

1Q15 = MIXED BAG

Management issued particularly light 1Q15 revenue guidance, implying nearly 10 percentage points of deceleration in y/y revenue growth from 4Q14 to 1Q15 (from 33% to 24% at the midpoint of guidance).  We’re expecting 29% revenue growth (vs. consensus of 25%) given continuing strength in local advertising and the embedded y/y tailwind on its higher-ARPU subscription product from the 25-33% price increase late in 1Q14. 

However, we are expecting user growth to disappoint.  We believe consensus is putting too much stock into P’s 4Q14 acceleration, which came off a particularly weak comp.  In 4Q13, P experienced its worst deceleration in y/y active listener growth in its reported history following its redesigned ad feed late in 3Q13 (switched from single to double ad feed, and increased max ad load from 4 to 6).  The other thing to consider is that the first quarter is seasonally slower.  We don't believe P can sustain +80M active users that the street is expecting. 

P: Thoughts into the Print (1Q15) - P   User growth detail 4Q14  

SETUP GETS WORSE FROM HERE

1Q15 may be P's best release of the year.  We’re expecting revenues could disappoint in 2H with consensus calling for accelerating ad revenue growth through 2015; a situation that essentially requires accelerating growth in P's two competing growth drivers (Ad-Supported Listener Hours and Advertising RPMs). 

P: Thoughts into the Print (1Q15) - P   2H15 Ad rev scen

But the two more important headwinds are Web IV and Active User growth.  We expect Web IV to increasingly dominate the story as we draw closer to the CRB decision (expected by Dec 15th).  We also expect active users to decline on a y/y basis in 2H15.

Regarding users, we estimate that P’s remaining TAM isn’t large enough to offset its heightened churn issues for much longer, and as we move closer to year end, penetrating what remains of P’s TAM (mostly older) will become more challenging.  For more detail, see the note below.

P: New Best Idea (Short)

12/22/14 03:56 PM EST

[click here

WHAT WE’RE KEYING IN ON

Listener Hours.  Our focus moving forward is Web IV.  We’re expecting P to lose the one debate that it can’t on royalty rates (different rates for ad-supported vs. subscription music).  If that winds up being the case, P could see a crippling increase in ad-supported royalty rates, and the more listener hours P enters 2016 with, the greater the profitability squeeze that would occur. 

P: Thoughts into the Print (1Q15) - P   Web IV scen P sub rates 3 

The obvious question is why we’re considering revenue as a secondary read.  The reason is that P’s revenue growth has been largely driven by a ramping investment in it’s a salesforce, with S&M expenses growing as a percentage of annual revenue since 2012.  If Web IV goes against P, its ability to continue investing in its salesforce would be limited at best, if not entirely dependent on managing its listener hours. 

In short, the best case scenario for P would be if user/hour growth decelerates as we expect this year.  If not, the situation would be far too sensitive, and P would have limited wiggle room to get this right (see table above).  P would not have the luxury of applying a simple listener cap, and hoping everything turns out ok.  P would need to take more drastic steps in 2016 to reign in content costs.  

Let us know if you have any questions, or would like to discuss in more detail.  For Web IV supporting analysis, see links below.  

Hesham Shaaban, CFA

@HedgeyeInternet 

WEBCASTER IV NOTES 

P: Losing the Critical Debate?

04/08/15 08:53 AM EDT

[click here]

P: Worst-Case Scenario? (Web IV)

03/23/15 09:30 AM EDT

[click here]

P: Webcaster IV = Powder Keg

01/13/15 02:49 PM EST

[click here]