What’s Pandora Stock Worth?

Credit: Pandora.

Now that Amazon.com (NASDAQ: AMZN  ) has launched its ad-free Prime Music service, some are questioning whether it's time to sell Pandora (NYSE: P  ) stock. I think that would be a mistake.

Prime Music is materially different from Pandora and rival Spotify. Both those services feature much larger catalogs, while supplying a richer playback experience. Pandora goes even further by creating a tailored music experience via its recommendations engine, based on 15-years work on the Music Genome Project.

The result? A business that analysts say is on track to grow profits more than 40% annually during the next five years -- disruptive growth that, I think, will be worth $15 billion in market cap by 2018, a near triple from today's prices.

How we'll get there
My thesis hinges on three key assumptions:

1. There's still magic in music discovery. Spotify and iTunes have done well helping audiophiles to build playlists. Prime Music is great for ad-free listening to favorite tracks from a limited catalog. Yet, none of these services offer the serendipity of radio. Pandora solves that problem while leveraging the Music Genome Project to give listeners more of what they'll like.

2. Pandora can capture a big portion of the ad dollars currently assigned to terrestrial radio stations. According to BIA/Kelsey, the total ad opportunity is on track to grow to $17 billion by next year. That's a huge number. In fact, Pandora could meet analysts' estimates for 25% annualized revenue growth over the next four years and still control only a small portion of the overall market.

3. Pandora should trade at a premium to industry peers. At present, Pandora trades for 7.6 times sales versus 2.8 for the broadcast-radio industry. A heady premium, to be sure, but deserved when you consider that Pandora is growing fast while disrupting the entire market for terrestrial radio. What's more, history  downplays the impact of new entrants such as Prime Music. Pandora scored huge gains in almost every area of the business in the fourth quarter, and that's in psite of a mid-September launch for iTunes Radio.

Valuation range
Now, let's do some math. The table shows a range of future market-cap estimates derived from current analyst forecasts, and multiplied by a series of revenue multiples -- half, double, or even with today's premium, as tracked by Yahoo! Finance.

Metrics
Worst Case 2018 Revenue Estimate
($1,763.20 million)
Average 2018 Revenue Estimate
($2,221.51 million)
Best Case 2018 Revenue Estimate
($3,131.40 million)

Worst Case Multiple
(3.75x revenue)

$6,611.25 million

$8,330.66 million

$11,742.75 million

Average Multiple
(7.5x revenue)

$13,224 million

$16,661.33 million

$23,485.50 million

Best Case Multiple
(15x revenue)

$26,448 million

$33,322.65 million

$46,971 million

Source: S&P Capital IQ.

I'll grant this is a wide range of outcomes, most of which won't come true. The bottom row represents the potential premium were Pandora to obliterate not only its Internet rivals but also its most dangerous terrestrial opponents. History and common sense says that's unlikely.

A better bet is that Pandora stock will continue to command 7.5 times sales come 2018, especially if the company delivers on Wall Street's estimate for 25% annualized revenue growth between now and then. Peer Sirius XM Holdings (NASDAQ: SIRI  ) still trades for 5 times sales after managing 18% annualized top-line growth over the past five years. Odds appear to favor the sort of outperformance that would result in a $15 billion or better market cap.

Now it's your turn to weigh in. Have a bear argument for Pandora stock? Let's hear it in the comments box below.

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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 June 19, 2014, at 9:27 AM, FrankMcNew wrote:

    My concern is profitability. Why are they not profitable when I would bet they are at pretty much the end of their land grab in the US. The customer base has stagnated.. Acquiring new customers in the last 5 quarters has been expensive. $250m spent on marketing & sales. 6k growth in listeners.....thats quite expensive when you consider revenue by customer.. The major question I would have is how much of their marketing is being used to acquire new customers V maintain what they have V Paying Users..if they strategy is paying customers..its a longer term play and requires larger investment..... If they turn off marketing are they profitable?

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