Pandora Media Inc.'s (P) recent earnings announcement was overshadowed by news that global investment firm KKR had agreed to buy $150 million in convertible preferred stock in the company. If the investment goes through, KKR will be paid a dividend and be able to convert the shares into common stock and/or cash. In addition, Richard Sarnoff, who oversees KKR's media and communications holdings in the Americas, will join Pandora's board of directors. That kind of money coming from a company of KKR's stature has created a buzz among investors who want to know what's going on.
About a year ago activist hedge fund Corvex began to acquire shares of Pandora and urged management to look at strategic alternatives including a sale. Sirius XM Holdings Inc. came into the picture as a potential buyer and while it looked in late March like the two had agreed to go their separate ways, rumors have recently surfaced that the two are still talking and some think there is hope the company can arrange a sale before the KKR deal goes through.
On May 8, Pandora announced that KKR had agreed to buy $150 million in Pandora convertible preferred stock. The preferred stock guarantees KKR will receive a quarterly dividend of 8% (in kind) or 7.5% (in cash).
The shares mature in 2022 and can be converted to common shares any time before the maturity date at an agreed-upon price of $13.50 per share. If Pandora shares go above the $13.50 price before the maturity date, KKR can get a great deal by exercising its option to convert the preferred shares to common shares. The KKR deal is not expected to close before June 8.
Why is Pandora doing this?
Pandora is in a tough business. Content costs range from 38% to 62% of annual average revenue per user. The company offers three levels of service (a free/ad-supported level and two ad-free subscription levels with different perks). The top level, the on-demand Pandora Premium, launched in March and while the company is building out its new music platform, it must pay for all the engineers, salespeople, and personnel to categorize the different songs. The result is that Pandora has been reducing its cash stockpile at a rate of about $40 million per quarter. The sale of stock to KKR would help bolster Pandora's balance sheet.
As CFO Naveen Chopra said it on the earnings call:
A strong balance sheet gives us the ability to accelerate growth investments when appropriate, to negotiate the best possible music licensing deals, and to compete aggressively in a rapidly changing, complex market. The proceeds will be used for general corporate purposes including potential investments in areas like such as advertising and marketing technologies, international expansion, and new types of content, if and when such opportunities are both available and yield compelling returns.
Here's the juicy part
KKR's agreement with Pandora is supposed to be completed within 30 days. There's a clause within the agreement allowing Pandora to call the deal off in return for paying a $15 million termination fee to KKR. In a separate press release, Pandora board member James Feuille said the following:
Having secured a significant financial commitment from KKR to strengthen the company's balance sheet, we have positioned the company to evaluate any potential strategic alternatives, including a sale, in the 30 days before the financing is set to close, I believe the steps we are taking today offer Pandora the ability to consider all opportunities and to set a course for the future.
The company also announced that Feuille and another board member, Peter Gotcher, will be leaving the board, and a committee has been formed to find their replacements.
CNBC's Scott Wapner reported on May 9 that the company expects to sell itself before the 30-day period expires and views the $15 million termination fee as buying it time.
Taking the opposite tact on May 9 was CNBC's David Faber, who said a deal probably wouldn't happen now that a financing deal has been put in place.
On May 17, the New York Post reported that Sirius XM was back in "active discussions" about acquiring Pandora.
What's an investor to do?
Although all this speculation is fascinating, it's not investable. Making a change in a portfolio based on chatter from unspecified sources is a fool's game. Being a long-term holder of Pandora shares, I'll stay tuned to see if anything happens in the next 30 days, but I wouldn't consider buying more shares based on recent events.
Oh, and the reason KKR is doing this deal is very simple: If Pandora opts out of the financing, KKR gets $15 million for its trouble. If the financing gets finalized, the company gets Pandora convertible preferred shares with an 8% quarterly dividend. Not a bad deal for KKR either way it works out.