Pandora CFO Predicts Better Scaled Royalty Payments, Points to Increased Mobile Monetization

Internet radio giant Pandora believes it can lower its royalty costs as a share of revenue by roughly 20 percentage points over the next one to three years, the company's new chief financial officer said Tuesday.
Pandora believes its content costs can get back to "40% with the right scale over the next one to three years," chief financial officer Mike Herring said at the ROTH Capital Conference in Laguna Niguel, California on Tuesday. Content costs, or the royalties Pandora pays the various performing rights organizations, were 61% of revenue in the company's latest fiscal year were 54% of revenue the prior year.
In other words, Pandora believes it can better manage its royalty costs before the current statutory rates end in 2015. But because statutory rates are fixed on a per-stream basis -- currently 0.12 cents per stream -- there is no way the company can decrease its cost burden without Congressional intervention. The only other option, although it is unlikely, is to grow revenues so successfully that pays the greater of a per-stream rate or 25% of revenue.
What the company can do is better monetize the mobile listening that accounts for 80% of its total listening hours. Mobile revenue per hour was $25 last fiscal quarter compared to $53 on the web. Herring said mobile advertising $25 per hour is above the company's cost per hour.
Pandora has supported legislation that could reduce its royalty burden by changing how the Copyright Royalty Board sets rates. Herring said the current statutory royalty rates are a barrier to entry because it dissuades companies from entering the free Internet radio market but added that Pandora wants that cost barrier to fall. "We're 77% market share of Internet radio, up from low 50s when we went public [fewer than] two years ago. That's partly because we're doing a great job serving our consumers and it's partly because it's really hard to play in this space because of the cost structure that's impose by these rules."
Subscriptions will remain a small part of Pandora's business as the company continues its mission of providing free Internet radio to as large an audience as possible. Herring says Pandora makes more per subscriber than it does per free listener, there is a bigger opportunity monetizing the 80% of people who rarely or never pay for music. "If you can monetize the 80%, that's a much bigger business than fighting with all the on-demand streaming players over the 20%" of consumers who actively pay for music.
Pandora will have a new CEO to help it grow mobile revenue and guide it through two years of arbitration hearings with the Copyright Royalty Board. Outgoing CEO Joe "recognizes that Pandora is at an inflection point from a business model perspective" and will start arbitration with the Copyright Royalty Board in January over statutory royalty rates, Herring said. "To have the right person in that role for the next level of business model inflection, as well as the energy level to represent the company in [the arbitration] environment, now is the time to make that change." No replacement for Kennedy or a date for his departure have been announced.