Great Product Idea = Great Stock Idea?

Pandora Media's (NYSE: P  ) coolness is in its genes. From the beginning, Pandora's Music Genome Project fit beautifully into today's uber-connected world, where individual tastes rule and passive consumption of media is becoming passe. Today, Pandora has more than 125 million registered users and 47 million active ones.

Pandora has cool cred and some passionate fans. But is it a cool stock idea? It has some major risks, but given the stock's fall from its IPO highs, it's looking like a good time to buy if you're not too averse to some real risks.

What's in Pandora's box?
Pandora's been narrowing its loss and is closer than ever to turning a profit. In the year ended January 2012, the company's revenue surged by 99.1% to $274.3 million, and it reported a loss of $16.1 million, or $0.19 per share.

That's quite an improvement from the year ended January 2009, when Pandora generated only $19.3 million in sales and reported a loss of $28.2 million, or $5.45 per share.

Analysts expect Pandora to steadily increase its revenue over the next several years, and that it will just turn a profit in the year ended January 2014. In other words, 2013 should be a very good year for Pandora, at least if all goes as expected.

Will it, though? Pandora competes with music services galore, and consumers have no shortage of ways to access tunes these days. Plus, there's only so much time in the day for listening to music (unless your full occupation is to Occupy Wall Street or something -- I'd imagine there's plenty of downtime).

Pandora competes with more established radio companies like Sirius XM, Clear Channel, and CBS, not to mention services provided by Apple's iTunes, Google (Nasdaq: GOOG  ) , and Amazon.com. Social-media musical service Spotify poses a major danger to Pandora, too; it also offers free listening pleasure and has major real estate in Facebook users' newsfeeds.

As is so often the case, some of these competitor companies may in some way be linked up; for example, Google actually acts as an "online advertising agency" for Pandora and represented 2.7% of the company's revenue last year.

Meanwhile, Pandora's licensing agreements require it to pay artists and their labels royalties for their content. These costs have hampered its profitability even though Pandora users only stream content, they don't buy it. It's a bit unfair, too, when you consider that Pandora's exposing listeners to new artists for free and creating new potential fans, not to mention paying concertgoers and merchandise purchasers.

Last year Pandora shelled out $150 million in royalties. Obviously, that takes a big bite out of all the sales it's managed to drum up through new advertising strategies in its streaming product, and in a case of the double-edged sword of success, the more listeners Pandora serves, the more royalty payouts it makes.

Pandora's negotiated royalty rates are due to increase a bit over the coming years, and it may have to use the courtroom in an attempt to renegotiate rate terms for the 2016-2020 period, which could add up to higher costs in the future.

Pandora: the price is right
Pandora shares are down nearly 40% since the company went public, marking a far better buying opportunity now. While far from a sure thing, this reduces the risk of buying in and ups the chance for stellar rewards.

Since it's not yet profitable, we can glance at Pandora's current price-to-sales ratio of just 5.90, compared with other as-yet-unprofitable recent IPOs with higher P/S ratios, such as Angie's List (Nasdaq: ANGI  ) (P/S ratio: 7.72), Yelp (Nasdaq: YELP  ) (P/S ratio: 13.01), and (oh my goodness!) Splunk (Nasdaq: SPLK  ) (P/S ratio: 23.73).

When I decided to take a look at Pandora, I assumed I'd decide its shares were poison, given its lack of profitability and the competitive landscape. So much for assumptions. I'm thinking the price just may be right for a company that's nearing profitability and has been admirably increasing revenue and loyal fans and emphasizing the discovery of new music that's geared to fit individuals' tastes.

I'm putting Pandora on my watch list; there are some clear risks, no doubt, but its cool hunting core could help it keep on growing goodwill into the future. Would you buy Pandora now? Broadcast your thoughts in the comment box below.

If Pandora isn't a good fit for your portfolios, check out the companies our analysts have identified in our special report "3 Stocks To Own For The New Industrial Revolution". Access your report, absolutely free.

Alyce Lomax owns no shares of any of the companies mentioned. The Motley Fool owns shares of Amazon.com, Apple, and Google. Motley Fool newsletter services have recommended buying shares of Amazon.com, Google, and Apple and creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (8) | Recommend This Article (3)

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  • Report this Comment On June 09, 2012, at 12:33 PM, nilvest wrote:

    Alyce, nice article. I am long Pandora and read every article on Pandora there is on Internet. You are one of very very few people who can see through the clutter and see the gem in the rough.

    It's simple - Pandora's content cost has been running ahead of revenue because people love this service. It's easy for some one to sign up and start listening - running the cost for Pandora. It takes time to go find advertisers to pay for that newly added cost... But at the rate Pandora is growing revenue, it's clear that revenue will not only they will catch up with rising cost but go a lot farther.

  • Report this Comment On June 10, 2012, at 3:48 AM, orderartwork wrote:

    http://beta.fool.com/mhenage/2012/06/08/pandoras-box-costs/5...

    Pandora Media (NYSE: P) has a fascinating business model and service. Listeners are allowed to listen to up to 100 personalized stations of music and comedy. On a computer or even on an iPad or other tablet with wifi, Pandora is great. The service lets you pick an artist, song, or album and then makes a virtual radio station based on songs or artists that go well with your original choice. Pandora offers all of this at no charge as long as you're willing to accept a few ads. You can also upgrade your experience for $3 a month and eliminate all of the ads. This sounds good and Alyce Lomax of The Motley Fool is impressed enough that she said “I'm thinking the price just may be right for a company that is nearing profitability”.

    Respectfully Alyce and I are going to have to disagree on this one. Pandora offers a great service, but I don't see the company as “nearing profitability”. There are several issues with the service as an investment that I can't get past. First, the company is in competition with multiple other innovators that offer similar and in some cases better service. A great example is Spotify, this service allows you to listen to the actual songs or albums you choose without having other songs chosen for you. While it's a little more expensive if you want to port this to a device like an iPad, the service allows you to have as large of a music collection as you want without worrying about storage on your device. Since both services are offered for free online, Spotify would seem to be a better option than Pandora on a traditional computer.

    I've heard several people say that they consider Pandora to be a serious competitor to SiriusXM (NASDAQ: SIRI). There is one big hole in this theory. The difference between Pandora and SiriusXM is, in most cases SiriusXM is built into the vehicles' sound system versus Pandora usually has to be connected through a smartphone. Though streaming music through a smartphone isn't a terrible idea, it does require both a strong enough signal for quality sound, and it uses data from the individual's data plan. Since signal strength is unpredictable and data usage is more desired for apps and information, this wouldn't seem to be a great trade-off.

    When you compare Pandora and its 125 million registered users to SiriusXM's nearly 22 million paying subscribers, I would rather have 22 million pay to use a service than to have 5 times as many paying little to nothing. Alyce Lomax says in the aforementioned article that, “Pandora's been narrowing its loss and is closer than ever to turning a profit.” The trouble with this statement is some of the company's numbers don't bear out that conclusion. In the company's most recent earnings report, Pandora showed that total revenue grew 58%, however, content acquisition costs increased by 91.43%. The problem with the Pandora model is the more a song is played, the more the company has to pay for royalties. This isn't a model where more users means more profits. Quite simply, more users means more costs. While Alyce points out that these listeners turn into new fans, concertgoers, and merchandise purchases, that is also true of traditional radio which is not compensated for these gains. There are a few other issues that came up in the company's most recent earnings as well.

    While the company might want its future growth to be based on subscriptions, this part of the business is not only growing slower, but also is only 20% of total revenues. Advertising is Pandora's main revenue driver and is growing faster so the company needs to stick with what it does best. While the popularity of the service is apparent with 53% active user growth, and 92% growth in listener hours, this does not equate to bigger profits. The company reported a non-GAAP loss per share of $0.09. These results were better than expected, but with nearly 6% of total U.S. Radio listening and the company still showing a loss, you have to wonder, what percentage of listeners does the company need to achieve a profit? In addition, one of the company's comments is good news and yet disconcerting for the future. The company said, "the majority of the top 50 digital advertisers in the U.S. already have bought multiplatform advertising on Pandora." This speaks to the popularity of the service, but begs the question, if most of the top 50 have already signed up, where do the big hits come from going forward.? Last, on a full year basis, Pandora expects an EPS loss of $0.07 to $0.011. This guidance comes in a little above estimates, but again still means the company is expected to lose money this whole year.

    The music business is constantly changing, and Pandora does offer a great service. However, until the company can change its licensing costs to a different structure, I don't see big profits in the future. Gaining more listeners, who use the service more often, will result in actually higher costs. A business that grows its costs at least as fast as revenues is not going to be a great investment. Love the service, but I won't be buying the stock anytime soon.

  • Report this Comment On June 10, 2012, at 4:02 AM, orderartwork wrote:

    Alyce Lomax is is talking about Pandora P/S, which is really misleading people since Pandora grows its costs at least as fast as revenues (faster now!!!). There is no value for Pandora's P/S since its sale does not bring it profit!!!!.

    By the way Pandora sales marketing costs growth outpace revenue too (64%:58%) besides its royalties growth out revenue growth(91.43%:58%)

    I think Alyce Lomax is either lack of basic investment knowledge or lack of integrity.

    If you listen to him, I am sure you will lose your money!!!

  • Report this Comment On June 10, 2012, at 4:06 AM, orderartwork wrote:

    Here are royalties:

    Pandora's Pureplay Rate

    Year Non-Subscription Subscription

    2012 $0.0011 $0.0020

    2013 $0.0012 $0.0022

    2014 $0.0013 $0.0023

    2015 $0.0014 $0.0025

    As you can see, Pandora will continue to pay higher fees through 2015. Now, there is some debate as to whether Pandora will pay higher fees after 2015, or negotiate a better contract thereafter. I agree with you to think SoundExchange will not give Pandora a break. I am expecting to see SoundExchange continue to force Pandora to pay the price.

    The good news is that Pandora users that do not sign up for Pandora One cost Pandora less money. On the other hand, these non-subscription users are not contributing to Pandora; unless they are clicking on the ads. Therefore Pandora is simply paying for these listeners without receiving anything in return. This sounds more like a charity service as opposed to a business to me.

    These reasons are why Pandora is great charity service but not such great stocks. There will always be somebody taking advantage of it. Whether it be SoundExchange exploiting Pandora; it will continue to have speed bumps. Regulators will also continue to side with the SoundExchange because it would be ridiculous to avoid paying musicians for their work.

    With that said, if a cap is placed on costs then we will see Pandora's margins improve. This may be an option to wait until at least 2016.

    Is there anything I am missing?.

  • Report this Comment On June 11, 2012, at 1:03 AM, orderartwork wrote:

    Royalty fees is key for Pandora. This is its weakest part which Pandora is different from other social media companies, Pandora does not own content and has to pay huge royalty fees which FB and other social media companies do not have to pay their content.More royalty fees Pandora will pay, more listening hours are. Royalty fees has a majority of Pandora revenue.

    When Alyce Lomax comapre Pandora p/s with other IPOs with higher P/S ratios, such as Angie's List (Nasdaq: ANGI ) (P/S ratio: 7.72), Yelp (Nasdaq: YELP ) (P/S ratio: 13.01), and (oh my goodness!) Splunk (Nasdaq: SPLK ) (P/S ratio: 23.73), do they have to pay a majority of revenue for their content fee, which will grow faster than their revenue?

    If they do not pay Royalty fees for their contents, I think Alyce Lomax should cut down Royalty fees from Pandora revenue as fair revenue to calculate Pandora p/s. I am sure Pandora will the highest p/s among these IPO and most social media companies.

    I think Alyce Lomax is either lack of basic investment knowledge or lack of integrity by misleading people.

  • Report this Comment On June 11, 2012, at 1:04 AM, orderartwork wrote:

    Why is growing mobile listening killing Pandora

    "To date, we have not been able to generate revenue from our advertising products delivered to mobile devices as effectively as we have for our advertising products served on traditional computers."

    -- From the "Risk Factors" section of the Pandora Media (P) 10-K, filed March 19th

    CEO Joe Kennedy noted on the Q1 conference call last week that mobile listening was now closer to roughly 70 percent."

    Pandora generated 55% of its advertising revenue from mobile, yet saw 70% of its listening hours in the segment. As such, desktop users are nearly twice as valuable on a revenue basis as mobile users.

    Pandora should see significant pressure as mobile-aided user growth is offset by lower, mobile-induced revenue per user. You should know Pandora has to pay mobile listening. When mobile listening hours is growing faster, however revenue from mobile per user is much worse than desktop users, which will make Pandora lose more money since content cost from usage is growing faster!!!!

    perhaps the best summation of the company's problems came from CFO John Cakebread on the conference call. Giving guidance for fiscal year 2013, Cakebread noted [emphasis mine]:

    For fiscal 2013 [we] expect negative cash flow from operations, resulting primarily from increased listener hours and resulting content spend.

    So while analysts and commentators were celebrating the massive increase in listener hours, the company was pointing out that very same increase as the key driver for the reversal from (modestly) positive OCF in FY12 to negative OCF in fiscal 2013.

  • Report this Comment On June 11, 2012, at 3:47 AM, dag154 wrote:

    When you need to use P/S insted of P/E, soething in missing. And a P/S of 5,9 is good? Talk about value investing inverserd ...

  • Report this Comment On June 12, 2012, at 10:32 PM, orderartwork wrote:

    http://seekingalpha.com/article/654191-h...

    Pandora provides internet radio services and has 70% share of the total U.S. internet radio industry. The company makes money via advertising and paid subscriptions on its website, mobile and other platforms while paying the content acquisition costs (royalties) to the music companies for user played radio content. The growth in 1Q2012 revenue was primarily offset by an increase in content acquisition costs.

    Moreover, Pandora has been unable to monetize its large user base of 150 million, and the sustainability of its business model is questionable, given the historical financial performance. We expect the growth in earnings to decline further and recommend selling the stock. Risks to Pandora include a falling active user base, decrease in the number of listening hours, less spending by clients on advertising, and increasing content acquisition costs.

    Pandora (P) has been unable to monetize its large user base of 150 million. The sustainability of the business model is questionable given the historical financial performance. We expect the growth in earnings to halt and recommend a short position.

    Author:

    Qineqt:Team of investment professionals including former hedge fund manager, trader and analyst at top tier $10 billion hedge fund. Members include investment professionals who oversaw research and trading organization of 50+.

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