INTRO: We’re planning to host a call within the next few weeks to run though our updated thesis. The below is a quick summary of what is currently top of mind. Let us know if you would like to run through the supporting analysis in more detail.
KEY POINTS
- SHIFTING GEARS: We’re not talking about the sub opportunity, but more of a structural shift as to how P is approaching its business. P appears to be making its users pay for their music one way or another. We’ve noticed a particularly sharp surge in ad load lately, which has been largely
corroborated by the early results of our survey. Naturally rising ad load should help drive RPM growth while also serving as a catalyst for subs adds, especially since some of that ad load is promoting Pandora Plus. But more importantly, that ad load could cut some of the fat (hours) out of the model since some users will initially fade it. For context, P has to pay for every ad-supported track it streams, but historically it hasn’t been monetizing all of its users’ hours. That said, rising RPMs against potentially declining hours = improving gross profit. Granted, some of the street may view any slippage in P’s user metrics as a longer-term concern (Point 2), but we suspect improving monetization to overshadow its listener metrics this year since the former seems to be the center of the debate, and mgmt already flagged declining ad-supported hours for 2017.
- CHURN RISK? We suspect any ad-induced churn would be short-lived, and could effectively serve as a Trojan horse across the industry. First, there’s not much competition left on the ad-supported side; most of which comes with less functionality and comparable if not more ad load. In turn, any defecting users would learn to accept that ad load on an inferior service, so they would likely find their way back to P. For IHRT specifically, we’re not sure if it could even afford the incremental web traffic given its financial situation since it also has to pay per track (including Simulcast). Spotify is the exception, but its free tier has been a major point of contention across the industry. Spotify doesn’t pay per track but as a percentage of total revenue, which is largely sourced from subscriptions. That said, the Labels’ streaming revenues would likely decline if Spotify absorbs more of P’s traffic, which would add more pressure on Spotify to curb its free tier as part of any new deals (currently going month-to-month on expired deals). If (when) that happens, P can pretty much do anything it wants with the ad model (listener caps?).
- SUB UPDATE: P began rolling out its interactive “Premium” subscription (e.g. Spotify) to select users today, with the full launch expected in the “coming weeks”, which likely means 2Q. Existing Pandora Plus subs will automatically be upgraded into Premium for a 6-month trial. The positive is that P has pretty much eliminated all churn risk related to Plus subs opting into another interactive service for the time being. P may even see a bump in Plus sub adds into quarter-end depending on how much press coverage the six-month Premium trial receives. Plus subs will likley automatically convert to paying Premium subs when the trial lapses, so the upgrade decision switches to opting out vs. opting in. The best case scenario would be 100% sub revenue growth from the ARPU lift. However, the negative is that P may not see much Premium revenue this year since the bulk of that opportunity is likely sourced from upselling existing Plus subs, which won’t start paying for Premium till 4Q17 when the trials lapse.
KEY CHARTS
AD LOAD SURVEY: Roughly half of our survey respondents suggested they were experiencing more ad load, with a quarter suggesting a material increase. The focal point of the survey is the 18-34 yr-old demos since they are naturally the most active users, therefore a better reflection of how much P is increasing ad load.
REVENUE/HOUR: This chart is not so much about runway, but a reflection of how poorly the ad model has been monetized. This dynamic exists because of limited salesforce leverage + caution around ad load increases for fear of pushing its users away. Our survey above combined with P's soft guide for declining ad-supported hours suggests monetization is the priority moving forward.
P MAKES ITS SUB MARKET: The obvious sub target is the heavy ad-supported user, which is evident in the chart below with decelerating ad-supported hours/user when sub growth accelerates (correlation 1Q13-4Q16: -.66, 1Q15-4Q16: -.75). P's experience with the 40-hr mobile listener cap suggests that the user won't pay unless prodded to do so. We suspect this is the main reason for the above-mentioned ad load increases (i.e. push the power users into subscriptions).
