Pandora Media Inc (NYSE:P)’s valuation is becoming more attractive, according to MKM Partners analysts. However, they do still see a risk to the stock, as higher content costs could become a headwind. In a report dated May 12, 2014, analyst Rob Sanderson upgraded Pandora Media Inc (NYSE:P) from Neutral to Buy and set a $32 per share price target. He said he’s come “full circle” on Pandora because of three big changes in his opinion since he initiated coverage on it with a Sell rating about a year ago.

Pandora

Why Pandora is now a Buy

First, he said Pandora Media Inc (NYSE:P)’s platform has turned out to be stickier than he thought it would be compared to competition. He noted that Apple Inc. (NASDAQ:AAPL)’s iTunes Radio has not done well and that iTunes in general is becoming less and less irrelevant as time goes on.

Second, he believes Pandora Media Inc (NYSE:P)’s ramp in ad monetization is “crossing profitability thresholds with strength.” He says the company is on track to turn the negative from its model with high fixed costs into a positive.

And third, he said he has “a greater appreciation” for how well Pandora Media Inc (NYSE:P) is able to target its advertisements to consumers. He noted that the streaming music provider doesn’t just take its share of radio ad dollars “on the back of audience gains.” Instead, he said Pandora is becoming increasingly able to offer marketers a more effective strategy to reach mobile listeners.

Pandora could face higher content costs

He also said that one unknown factor right now is content costs. Pandora Media Inc (NYSE:P) is currently involved in discussions about renewal of its licensing terms with SoundExchange. That license covers most of the company’s content costs and expires after 2015.

The analyst is assuming a 7% increase each year in streaming cost per hour for 2016 and 2017 and 5% for 2018 through 2020. He said if the increases are higher than 250 basis point per year, Pandora Media Inc (NYSE:P) would lose about 35 cents per share from his 2020 earnings per share estimate, assuming the rest of his model doesn’t change.

However, he also believes that higher content costs would be a problem that’s easier for Pandora Media Inc (NYSE:P) to face than many of its competitors because the company has “cleared this bar well before others.”

Updating Pandora’s model

Sanderson now estimates that Pandora Media Inc (NYSE:P)’s listener hours will expand 14% compound annual growth through 2017 and then 11% through 2020. He assumes the company’s share of industry listening hours increases from 8% last year to 13% by 2017 and then 1% in 2020.