Pandora is growing up, and it smells like teen spirit

Entertain us, indeed. The Web radio service is standing tall in the mosh pit of Internet radio, giving fans and investors alike reason to rave.

Pandora

Pandora turned 13 this year. An identity crisis would be right on time.

But the operator of the Internet's biggest radio service seems to know exactly what it wants to be when it grows up. Its dream: become an advertising-powered heavyweight, holding its own against any of the radio giants that, for now, gorge on the lion's share of the estimated $14 billion radio-ad market. Yes, that also means leaving Apple and its nascent iTunes Radio music service in the dust.

Pandora appears on the path to get there ahead of its third-quarter earnings report Thursday, with a new ad-man CEO, aggressive investments in its ad salesforce, and integration into the forums that advertisers turn to to make their media buys. As Pandora's growth in revenue calms down from the 185 percent of 2010 to the 55 percent of last year, the business of being profitable is getting more scrutiny, and at the moment the only worries are whether Pandora's many fans have gotten ahead of themselves.

But there's reason to be hopeful, as investors certainly are. The stock has nearly quadrupled over the past year.

Change at the top
That fervor over Pandora stems from the perception its advertising model is ripening. The loss-making company has posted only a couple quarters of slim profit since going public in 2011, bogged down by music licensing costs that eat into more than half its revenue. But now several ad-focused moves are coinciding, and most watchers are expecting harmony.

Thursday's update on Pandora's business will be led by a new figure, recently hired Chief Executive Brian McAndrews. In September, he succeeded Joe Kennedy, who led Pandora for nearly a decade.

Pandora CEO Brian McAndrews. Pandora

While Pandora thrived as a radio service under Kennedy, breaking away from a pack of streaming music options to dominate with more than 70 million active monthly users, McAndrews is the kind of executive you hire to thrive in the ad world. He's unmistakably a marketing exec , previously serving as senior vice president of Microsoft's "Advertiser & Publisher Solutions" group, and before that as chief of digital marketing company Aquantive until Microsoft bought it for $6 billion. (Kennedy's exit from Pandora was planned, having been previously announced in March.)

In an interview last month with CNET, Pandora Chief Financial Officer Mike Herring credited Kennedy's navigation of tricky licensing waters with getting the company where it is, but said Pandora has reached a level with new demands. "Brian is a very highly regarded exec in the tech world; his career has been built on bringing media, tech, and advertising together," he said. "It's the perfect time to see a transition."

Read: Pandora CFO: We do Internet Radio 'better than anyone' (Q&A)
In bloom
McAndrews arrived at a company with a big ad-development push already in progress. Pandora has been building up a force of salespeople focused on local ads, the kind you hear for a neighborhood car dealership or your city's biggest campus bar. Pandora's local-ad force reached 29 out of 40 top radio markets, as of August.

It's a big market -- local ads were estimated at $132.9 billion this year -- and its digital growth is exploding. BIA/Kelsey, a local-media research, consulting, and advisory firm, this week projected revenue from US online and digital local ads would rise at a 13.8 percent compound annual rate over the next four years. The growth rate for traditional advertising revenue? A paltry 0.1 percent.

Apple unveils iTunes Radio at WWDC 2013.
Apple unveils iTunes Radio at WWDC 2013. Pandora

Helping Pandora get a bigger piece of that pie is its integration onto the same ad-buying platforms where radio stations compete for marketing dollars. These services, Strata and Mediaocean, put Pandora's stats alongside those of its terrestrial competitors in forums that account for the overwhelming majority of local ad sales. Stacked up against traditional radio, Pandora has the added appeal of targeted listeners for advertisers, thanks to its wealth of data about them: location, age, and taste preferences.

Pandora's local advertising push is still in its early stages, but results Thursday may provide a clearer picture of how powerful -- or not -- these initiatives could be for the company. So far, Pandora's advertising revenue has been moving in the right direction. Local-ad revenue in the previous three-month period was nearly equal to all the local ad sales for the 2013 fiscal year. A financial measure called RPM, the company's revenue from 1,000 ad impressions, has accelerated for its mobile advertising in each of the last four quarters, which is important as mobile makes up more than 80 percent of Pandora's music listening now.

If you're a regular Pandora listener, you've probably noticed an uptick in the number of ads your hearing, too. The company introduced a "back-to-back" audio ad unit that increased the potential number of commercials to 4 or more per hour from 3.5, according to Susquehanna analyst Brian Nowak. That may seem like an incremental change, but spread that extra bit of advertising per hour over 1.47 billion hours that listeners spent streaming music just last month, and it makes a difference.

Early relief
Pandora's darkest overhang this year has been Apple's introduction of iTunes Radio. Apple released its rival Internet radio service on September 18 in the US and notched more than 11 million unique listeners in the first five days after its launch on iOS 7 and the desktop iTunes software.

That put iTunes Radio on pace to surpass Pandora in less than 30 days if it was sustained, but it wasn't. Last month, Apple revealed that iTunes Radio has reached 20 million users listening to a billion songs. It took about five weeks to come within range of doubling the figure it hit in the first five days. Pandora, by comparison, has more than 70 million monthly active listeners.

Hyundai Pandora interface
Hyundai

As data about iTunes Radio emerged, analysts' number crunching indicated Pandora's pain was minimal. They noted that iTunes Radio listeners appeared to spend 75 percent less time on the service than Pandora, that 92 percent of survey respondents who had tried iTunes Radio said they still use Pandora, and that daily tweets about Pandora show up 6 to 12 times as frequently as chatter about iTunes Radio.

When Pandora released monthly audience figures in October, the first full month with Apple's online radio service as a rival, the data wasn't a home run, but it backed up the speculation it was faring fine. Pandora's listener hours were up 18 percent from a year earlier, basically on par with the increase seen the month before.

Too soon?
However, Pandora's number of unique listeners fell back from the month before. Fewer listeners streaming more music, while not the worst of all possible outcomes, is not the most favorable one financially for the ad-based company. Pandora rings up most of its costs based on how much music is streamed, and improves its revenue power by having the greatest audience reach for advertisers.

In other words, last month, costs kept going up while its revenue engine slipped into a lower gear. And the data from October was only a first glimpse at how iTunes Radio is affecting the current leader in Internet radio.

Still, the combination of defused iTunes Radio worries while Pandora's advertising push gains steam has blasted the company's stock 280 percent higher in the last year. A year ago, Pandora was reporting 67 percent growth in listener hours and 60 percent growth in revenue. Now, those percentages are expected to taper down to 17 percent and 46 percent, respectively.

Pandora is bumping up against the same problem that all high-growth, newly public companies eventually do: the sustainability of its momentum. As it matures, it needs to get down to the business of turning a profit rather than simple frenetic growth.

Investors clearly believe the company has all the advertising factors working in its favor to do just that. Now it's up to Pandora to show up with bottom lines in the black rather than the red.

 

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