Pandora Could Be Devastated by a Free Spotify

I am utterly baffled by Pandora's (NYSE: P  ) steady share-price appreciation. It's an unprofitable company with an unproven business model whose major competitors include Apple (NASDAQ: AAPL  ) and Google (NASDAQ: GOOGL  ) , two of the largest and most powerful tech companies in the world, and who incidentally happen to own the platforms Pandora depends on to reach the overwhelming majority of its listeners.

But while I think Apple and Google's expansion into the market could ultimately prove overwhelming for Pandora in the long run, Spotify's new initiative has the potential to be even more detrimental.

Spotify goes free
Pandora's management would tell you Spotify isn't a competitor in the true sense of the word. Spotify offers on-demand music; if you want to listen to a particular song or a particular artist, Spotify will let you do that. But sometimes you don't want to -- sometimes you want to kick back and be served up a steady stream of songs. That's where Pandora comes in.

It's possible that Spotify and Pandora are serving two distinct markets. In reality, if you look at the listener metrics, I think it's obvious that demand for both services is highly overlapping -- Pandora simply benefits from an uneven playing field.

There's an important distinction here: desktop and mobile. If you're on a traditional PC, both Spotify and Pandora are free to use. But for most people, listening to music is better on the go, such as in the car, at the gym, or walking around town -- times when you're far away from your computer. In those instances, listeners turn to their smartphone or tablet -- where Pandora's massive advantage comes into play.

On mobile devices, Pandora's service is still free. Spotify's, however, is not -- if you aren't willing to pay a monthly fee, you're out of luck. But that is set to change next week, when Spotify is reportedly going to announce its own free option -- going forward, listeners will be able to access Spotify's service on their mobile device without paying. Over time, Spotify's free option should cannibalize many of Pandora's listeners.

Consider listener metrics: Spotify has about 24 million active listeners, but only 6 million of them are willing to pay for mobile access -- about 18 million stick with the free desktop option. In contrast, Pandora has many times more active listeners -- about 72.4 million -- but around 80% of them listen from a mobile device. That means that Pandora, despite having so many more total listeners, actually has fewer desktop listeners than Spotify.

In essence, other things being equal, listeners seem to prefer Spotify's service over Pandora's when both are free. Now, there may be other factors that could have an effect -- perhaps the desktop setup is better for selecting individual songs than a mobile interface -- but I think it's likely that Spotify's free option could rob Pandora of millions of listeners.

Apple and Google moving in
But I don't think Spotify's new initiative is, by itself, the single strike against Pandora. Rather, the entire space is seeing rapid advancement, and Pandora is facing a new competitor seemingly every quarter. Pandora shareholders cheered on November's active listener numbers: after a slight drop in October, Pandora posted a gain in November, suggesting the competitive threat from Apple's iTunes Radio was at most minor.

But Apple's iTunes Radio has only been around for just longer than two months, and music lies at the core of Apple's iOS ecosystem. Even if listeners prefer Pandora over Apple's iTunes radio right now, it's only logical to expect Apple to improve on its offerings. Moreover, as Apple moves into the living room and into the automobile, Apple as a competitor isn't going away anytime soon.

Owners of devices powered by Google's Android operating system can't access Apple's iTunes Radio even if they wanted to, giving Pandora an obvious advantage on Google's platform. But again, Google's option is new -- just about six months old -- and its evolution is ongoing. Google Music was only added to Apple's app store last month, and like Apple, Google has only begun to expand its Android ecosystem to the living room and into the automobile.

These long-term "what-if" scenarios may seem underwhelming -- the possibility of Google and Apple definitively crushing Pandora in the long-run is conjecture at this point. But Pandora isn't some established company -- it's a speculative investment at best, and it can't even reach the majority of its listeners without Apple and Google's help.

Pandora has been a great stock to own in 2013
I've been bearish on Pandora for months, and for months I've been completely wrong. In just the past six months alone, Pandora shares have almost doubled. Year to date, they're up more than 200%.

Ultimately, however, I remain as negative on Pandora as ever before. This is an unprofitable company with a terrible story, beset by challengers on every side. In the long run, Apple and Google could weigh heavily on Pandora -- their platform ownership gives them the upper hand -- but in the near term, competition from a free Spotify could be even more devastating. Pandora shares might continue to run, but this is one stock I think long-term investors should avoid.

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  • Report this Comment On December 09, 2013, at 9:52 AM, gregphil22 wrote:

    SAME OLD SONG. First, the music business was going to destroy Pandora because Pandora was fighting royalty fees. Remember that one...artists were pulling music off the service... now many have returned and actually embraced Pandora. Then Apple was going to destroy Pandora with their service. Apple announced their service back in August. Pandora has gone from $16 to nearly $30 a share since (and listeners are up too). Yep, Apple really has hurt the company. Now Spotify will be Pandora's demise. Same old song YAWN!.. (pardon the pun). These folks writing these articles DO NOT get it. Pandora has a unique ap/software that no one has. Listeners can customize their stations. Cant do that on Apple or Spotify. Not in the same user friendly way Pandora offers. NOBODY can offer music in that way..it is a Pandora exclusive. In fact, unlike the author I tried both services to see the difference. Spotfiy...it is about as user friendly as hammering a nail in a 2 x 4 with a high healed shoe when compared so Pandora. It makes sense to look at the "wall street" view of a company but it helps to actually use the products first and understand what the differences are. Pandora WILL and I say WILL be profitable next year...and the "this company is not profitable" has been used in the bear view of many a tech company. See Facebook, Sirus, Netflix, just to name a few. Bottom line ...know what the difference is between the company or more to the point the product you are comparing it to before you say how it is going "devastated" by the other.

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