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Takeaway: Today's announcement skewed slightly negative, but the key takeaway is that P's new cost structure favors the the sub model even more now.


  1. JUST THE BAD: In short, P was only able to offer us disappointing headline economics of its new deals without any real color on what it’s getting in return for offering these concessions.  That and it has only struck deals with 2 out of 3 major labels; there’s no timetable for when/if it will ink deals with Warner Music Group.  While we suspected P needed to give away a lot to get these deals done by year end, the headline economics were worse than we were expecting.  Most notably, P’s ad-supported content costs (Ad LPMs) are stepping up from a reported $30.65 in 1H16 to ~$33 moving forward.  In exchange, P will be receiving additional functionality on the ad-supported product that should also create more ad inventory.  Regarding the subscription model, P is expecting content costs in the range of 65% to 70% of revenue (consistent w/ Spotify), but that applies to the entire sub portfolio, which is also a step-up on its current offering that we estimate has content costs in the range of 50% to 55% of revenue.  Once again, P will be receiving additional sub functionality in return, but was unable to tell us what that will be.    
  2. SUB OR BUST? The ad-supported model is now even more expensive to run under these new terms, and while the additional functionality/ad inventory is a positive, monetizing that model has always proved difficult since it’s largely headcount (sales rep) dependent.  In short, the ad-supported model now just costs more without any guarantee of improved monetization.  That said, the economics of P’s model favors the subscription model even more now.  The question is how much mgmt will prioritize that model moving forward.  While the longer-term opportunity really depends on how aggressively P chooses to go to market with its expanded sub portfolio, a key tenet of our long thesis is that P really doesn't need that much conversion in the initial year post expansion to move the needle given how poorly the ad-supported model is monetized.  That said, we're comfortable staying long the initial year of the expansion, especially since we suspect take-out speculation/activist pressure to backstop any fundamental mishaps along the way.  

For more detail, see the note below and/or let us know if you would like a copy of our P Blackbook deck & replay.

Hesham Shaaban, CFA
Managing Director


P | New Best Idea (Long)
08/16/16 03:54 PM EDT
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