Pandora Finally Gets It Right -- Time to Sell

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For anyone who thinks this is going to be an article bashing Pandora Media (NYSE: P  ) , you've got it all wrong. The truth is, Pandora's business model is actually starting to make sense and that is exactly why it's time to sell... the company.

Doomed to fail but defying the critics
Many analysts and observers have been skeptical about Pandora's future from the very beginning. When Pandora plays a song it has to pay the artist a royalty. In this way, the more the service is being used, the more expensive the royalties.

While Pandora's overall operating expenses are still growing faster than revenue, it's not the company's content expenses that are to blame. Content costs increased by about 30% in the current quarter, but SG&A and other expenses grew much faster.

By contrast, Pandora reported overall advertising revenue grew 39%, and its subscription revenue increased by 132%. With subscription revenue now making up 19% of total revenue, and this revenue stream growing much faster, the company could generate more stable revenues in the future.

The bottom line is, Pandora is beginning to look like a business that will stick around. The challenge, of course is, all of a sudden every large company seems to want a part of the streaming music business. So where does Pandora go from here?

The best course of action for Pandora might be to make itself available for purchase at the right price. The company currently carries a market cap of about $7 billion, which is easily within the budgets of several of the largest players in the technology field.

Customers of Pandora, Apple's (NASDAQ: AAPL  ) iTunes Radio, Google's (NASDAQ: GOOGL  ) All Play Access, or even Microsoft's (NASDAQ: MSFT  ) Xbox Music Pass all have one thing in common. These listeners have found a reason to prefer the one service over the other.

With streaming video, it's not unusual for subscribers to have more than one service because there is significantly different content available. However, if a subscriber is paying $9.99 a month for Google's Play All Access package, are they likely to pay $9.99 to have Xbox Music Pass as well? Probably not.

Why should Pandora sell? Pandora has been around and widely publicized since about 2005. According to recent research, the company carries about 31% domestic market share. However, iTunes Radio didn't launch until September 2013 and already commands 8% of the market. Google's Play All Access is almost never mentioned or publicized, started in May 2013, and yet has managed a 2% market share.

Xbox Music didn't rank in the top 10, but the company sold more than 7 million Xbox consoles last quarter alone. If Microsoft hopes the new Xbox One will be the center of customers' entertainment systems, Xbox Music has to be part of that push.

Apple could have bought Pandora twice last quarter
Apple's $140 billion in net cash makes Pandora's $7 billion market cap look like peanuts. In fact, Apple generated enough core free cash flow in the last three months to buy Pandora almost two times over.

Apple could provide the resources to cut Pandora's SG&A expense growth and make the service more profitable. Apple would also benefit from tighter integration with iTunes in Pandora. Considering iTunes generated almost 8% of Apple's revenue last quarter, this wouldn't be insignificant.

No one does advertising like Google
Where Google is concerned, the company's Play All Access could be the top-tier offering at $9.99, Pandora One at $3.99 could be the mid-tier option, and Pandora's free radio would be for everyone else. With millions of Android devices being activated every day, imagine if Pandora were included as part of the Android system.

Google gets about 90% of its revenue from advertising. With more than 80% of Pandora's revenue from advertising, this seems like a match made in advertising heaven.

Microsoft could pull the trigger again
Though Microsoft might seem an unlikely suitor years ago, the company's purchase of Skype and Nokia's handset business proves the company is out to transform itself. With more than $60 billion in net cash and investments, it could easily pull the trigger again.

Microsoft could use Pandora, much like it is beginning to use Skype and its OneDrive cloud storage as offerings to entice buyers to the Windows platform. Pandora One along with free minutes of Skype calling, and free gigabytes of OneDrive storage, would be a tempting trifecta of offers.

A nice round number and a 30% gain
Of course, Pandora's stockholders wouldn't accept the current market cap in a buyout. While $7 billion for the company is likely out of the question, what if one of these big guns offered $10 billion? It might be difficult for stockholders and management to say no to a nice round number like that.

Pandora is on top of the domestic streaming market. It seems like now is the time for Apple, Google, or Microsoft to make a bid if for no other reason than to keep Pandora from falling into their competitors' hands.

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Read/Post Comments (4) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 13, 2014, at 1:56 PM, twolf2919 wrote:

    Yes, Apple could buy Pandora many times over - but "could" is hardly a good reason to do so!

    It doesn't seem to me that Apple has any real need for Pandora. They have already invested the resources to bring out a totally integrated, and roughly equivalent product that has already garnered 8% of the market, as you yourself indicated. Unlike Pandora, it already has international agreements with the labels to begin streaming in various countries. Sooner or later, it'll eat Pandora's lunch anyway - so why waste $10b to buy it?

  • Report this Comment On March 13, 2014, at 2:24 PM, JaredPorter wrote:

    It's true that iTunes Radio is already pulling past Pandora in international licensing rights, not to mention Apple's favoring its own service as the default positioning in Car Play and Apple TV. Perhaps Apple should be patient until its market share eclipses Pandora and then offer $3-4 BN to buy "the threatened" Pandora and add Pandora's subscriber base and alternate curatorship. Apple is gaining profits as it is starting to promote ITunes Radio more to advertisers. Also, ad-free Radio option through Apple is a bargain if one subscribes to AirPlay for only $20/year! Apple also benefits from iTunes Radio's convenient one-click song purchase feature, as its audience is listening online.

  • Report this Comment On March 13, 2014, at 2:43 PM, volgin wrote:

    You forget to mention that the same report mentions that more people use YouTube to listen to music (45%) than Pandora (31%). Once Google launches YouTube Music service, it will be the biggest music service almost overnight. So why buy Pandora?

    Apple, Google and Microsoft want global presence. They would rather buy Deezer, which operates in 182 countries, or Spotify, than Pandora.

  • Report this Comment On March 13, 2014, at 3:21 PM, greenember wrote:

    I have an idea for a killer feature that would put Pandora clearly ahead of the bunch. Wish I knew how to contact somebody important there!

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Chad Henage

Chad is a self professed tech nerd and has been investing for over 20 years. He follows nearly everything in the technology and consumer goods sectors, and is a huge fan of the Peter Lynch investing style. He has over 1,000 published articles about stocks and investing. You can follow Chad on Twitter at @chadscards1274.

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