Stock pick: Pandora Media Inc. (P) is worth tuning in to

Good news in listener growth

Chart showing trailing 12-month stock performance for Pandora Media inc.

On May 8, it was revealed that Apple was in talks to buy Beats by Dre, Dr. Dre’s headphone company, for $3.2 billion. While there’s been a massive debate online as to whether this is a good deal or not, some people think that Apple wants to buy the business for more than its fancy headphones. It also a subscription streaming music service that launched this year, something Apple has dabbled in, but to no great success.

Whether or not the deal will happen is still unclear, but one thing’s for certain: if Apple wants to buy into the streaming music space, then there’s no question that it’s here to stay. People don’t have to buy Apple, though, to take advantage of this growing trend. Pandora Media Inc. (NYSE: P), one of the leading online streaming music websites, is a favourite among analyst who cover this space.

On May 12, Rob Sanderson, an analyst with MKM Partners, upgraded Pandora from a neutral to a buy. One reason is that it continues to grow users and revenues much better than he expected. “The platform has proven more sticky than we expected in the face of competition,” he wrote in his report.

Last week, the company reported better than expected listener data. People listened to 1.7 billion hours of music that month, compared to 1.31 billion a year ago, an increase of 30%. There were also 76 million active users, compared to 70.1 at the same time last year.

Sanderson thinks that listening hours can expand at a 14% compound annual growth rate through 2017 and 11% through 2020, while its share of people who listen to music can grow from 8% in 2013 to 18% by 2020. Revenue per thousand impressions currently stand at about $38, but that will grow to $125 by 2020, he says.

Edward Williams, an analyst with BMO Capital Markets, also has a buy rating on Pandora and points out that the company is also getting in the traditional radio space. It bought a radio station last year and he thinks it will buy more.

“The continued growth in share augers well for Pandora as the company looks to extend its reach into local radio advertising markets,” he wrote in a May 6 report. “We continue to believe that Pandora is poised to benefit from protracted growth as the company further monetizes these local markets.”

One thing to watch out for is that its contract with SoundExchange, a license that covers most of its content costs, expires in 2016. Its costs to stream music will likely  rise; Sanderson says costs could increase by 7% a year in 2016 and 2017 and then 5% a year in 2018 to 2020. That would remove about $0.35 from his 2020 earnings per share estimate.

However, this will be an issue that every streaming site has to face and if Pandora can get it out of the way before others do, then it will be able to adjust faster than its competition.

The company is currently trading at about $24 a share, but Sanderson thinks it could hit $32 over the next 12 months. Williams is even more optimistic with a price target of $40.