Pandora Is in Trouble

I've gladly volunteered my input on why I won't buy Pandora Media (NYSE: P  ) .

Not only do I think the economics of its business model are flawed for investors, it also continues to be attacked from virtually every angle, even as it already goes against CBS' (NYSE: CBS  ) last.fm and Sirius XM Radio (Nasdaq: SIRI  ) .

The latest threat, and most credible in my Foolish mind, comes from Spotify. The European music service made it stateside over the summer, with fellow Fool Rick Munarriz saying Spotify won't kill Pandora.

Initially, the two services differed enough that they might have been able to play nicely together. Pandora offered its radio approach that took control out of the equation and served up similar tunes you might like. Spotify's promise was on-demand songs you could call up at a whim, along with some built-in social functionality. The service more directly competed with Apple's (Nasdaq: AAPL  ) iTunes (and its failed social network Ping) and other digital storefronts like Amazon.com's (Nasdaq: AMZN  ) MP3 Store and Google's (Nasdaq: GOOG  ) Music Store.

Spotify has now launched a Spotify Radio service. It's virtually identical to Pandora's pitch: "Starting a radio station is easy. Click 'Start Artist Radio' at the top of any artist page or just drag a track to 'Radio' in the left sidebar. Spotify will make a radio station of similar music." It even tops Pandora by allowing unlimited skips. In contrast, Pandora's free service limits your skips to 6 per hour and 12 total per day, in order to save on paying royalties.

I'd like to share a story that highlights my problem with Pandora's business. My wife subscribes to Pandora One, the pay service that removes ads and the daily skip limit. She recently told me how after an extended listening session, Pandora will interrupt the music and proactively ask her if she's still there listening. Since Pandora has to pay a royalty for each song delivered, it wants to be extra sure that she hasn't meandered off and left Pandora dumping money on deaf ears (if Pandora delivers a song in an empty forest, does it still pay a royalty?). The point is that Pandora is feeling the pinch of its royalties.

Even though Pandora was able to squeeze out a little black ink last quarter, the company still lacks scalability. While the revenue growth of 99% initially looks impressive, content acquisition costs outpaced that by increasing 108%. Those costs also comprised a slightly larger bulk of overall expenses -- 50.7% last quarter compared to 49.6% a year ago. Total expenses also jumped 103%, again outrunning revenue growth.

With Spotify launching a service that offers exactly what Pandora does, except without skip limits and with the on-demand offering, Pandora is in trouble.

Looking for a better mobile play than Pandora? The music streamer finds about 70% of its usage but only 1% of its advertising revenue from mobile usage. There's little doubt that mobile is a huge opportunity for the company, but its ability to find profits from those users is in doubt. For a better idea, The Motley Fool has a just released free report on mobile named "The Next Trillion Dollar Revolution" that details a "hidden" component play inside mobile phones that also is a market leader in the exploding Chinese market. Inside the report we not only describe why the mobile revolution will dwarf any other technology revolution seen before it, but we also name the company at the forefront of the trend. Hundreds of thousands have requested access to previous reports, but you can be among the first to access this just-released report by clicking here -- it's free.

Fool contributor Evan Niu owns shares of Apple and Amazon.com, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Google and Apple. Motley Fool newsletter services have recommended buying shares of Amazon.com, Google, and Apple, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On December 09, 2011, at 7:24 PM, CaSmiles wrote:

    Ok... but by that argument, Spotify might be in far worse shape than Pandora because they aren't paying attention to their royalties (unlimited skips)... and perhaps they'll go under soon, and Pandora's accountants will all get gigantic bonuses because they insisted on the "are you still listening" gizmo which Spotify doesn't have and should have had to stay financially viable...

    Like Amazon "selling below cost and making it up on volume", Spotify may be digging its own grave with both hands, right?

  • Report this Comment On December 09, 2011, at 10:22 PM, stockpost8 wrote:

    Actually Pandora's bottom line might be getting some help with the recent development.

    http://seekingalpha.com/article/312242-royalty-settlement-ma...

  • Report this Comment On December 09, 2011, at 11:47 PM, crankly09 wrote:

    Stockpost- That article just goes to show that the playing field may be more level now for ALL of the players in the field, not that P will become the profit leader of the pack.

    IMO & in agreement with the author- P's business model or service offering (plus lack of any intellectual property that a clever 14 year old could replicate) does not make it the 800 lb gorilla in this music streaming business. I also believe all of the company's in audio entertainment, besides SIRI and maybe Clear Channel, will all put each other out of business in the next 2 years.

    I could very well be wrong, but my money is staying as FAR AWAY from Pandora as possible.

  • Report this Comment On December 10, 2011, at 9:39 AM, stockpost8 wrote:

    You point is well taken. I would say Pandora is more like a portal, no one can say for sure it will still be popular years from now. But the key is that internet /mobile radio is a fast-growing field, and Pandora currently has the majority share.

  • Report this Comment On December 10, 2011, at 3:54 PM, crankly09 wrote:

    Stockpost- Agreed P and the streaming music biz are fast growing and P the marketshare......for now. We'll have to see if that's the case in 3-6-9-12 months....

    I believe the internet music boom will (and logically must) hit a plateau in popularity & profitability. Unless P's goal is to eventually count all 350 million of the US population as "subs", then they will soon hit a wall.

    This is not to be obtuse, but P claims to have 40 million + subs, what does that do for their bottom line? Spotify is already global and has more than 500,000 PAYING subs. Now Spotify finally has the same radio platform that P does, but without the skipping & ads. I would be worried about P.....not anyone else. I truly believe that their days are numbered (unless they are acquired), as competition grows every day and their fan base has no loyalty to P as a service. If you get something for free (P) and there are 7-10 other similar services you can also get for free, why would you be loyal to P?

    In the case of SIRI, Spotify and some others...they have paying subs, with semi-substantial monetary monthly commitments that create the necessity to use their product (i.e. the "stickiness" factor). 21 million and counting rely on/pay for SIRI and are personally & financaly invested. P and Spotify can not say the same.....but Spotify is at least on their way.

    Just my opinion and happy investing to all.

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