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Avoid Pandora's Hot IPO

By Rick Munarriz - Updated Apr 6, 2017 at 9:13PM

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It's not just your ears that are bleeding, Pandora.

Every week I write a column with a couple simple house rules.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Today we're throwing out the newest IPO flavor of the week: Come on down, Pandora Media (NYSE: P).

The song remains the same
It's easy to pitch Pandora as a sexy growth stock. Today's IPO debutante is a scorcher, accounting for half of the Internet radio listening market. The appeal of Pandora's music-discovery streams has helped it attract 90 million registered users.

The smartphone explosion has clearly helped, with Pandora's app consistently near the top across all five smartphone platforms that matter. An automaker or home theater component maker wouldn't even dare to attempt raising the tech bar without being Pandora-accessible.

Revenue spiked 150% to $137.8 million last year, with most of that coming in the form of ads that listeners tolerate in order to stream the largely free service. This year is off to another strong start with a 136% top-line boost.

There are holes in the model, though. Pandora can't seem to turn a profit, and after seeing its deficit narrow last year, the tech darling's net loss more than doubled during this year's freshman quarter.

Realizing that there has to be more to this model than obtrusive ads, Pandora began limiting access to 40 free hours a month. More active users -- or those who want to show their support in exchange for unlimited commercial-free streams -- can opt for the Pandora One premium service. Unfortunately, even after the hard Pandora One sell, Pandora is still losing gobs of money, and advertising accounts for 86% of the company's revenue.

Then we get to the valuation. Just a couple of weeks ago, Pandora was set to price its IPO as low as $7, implying a marginally reasonable market cap of $1.1 billion. Despite the fact that we've gone through six straight weeks of cascading stock prices and seen recent online IPOs implode, Pandora has bumped the number of shares it's offering higher, and its offering price has more than doubled.

With as many as 161.9 million shares outstanding if the overallotment is exercised -- and it will, since it's hard to pass up 2 million more shares at $16 apiece -- we're talking about a company that was priced at a whopping valuation of $2.6 billion. Today's feeding frenzy is driving that market cap even higher. The stock traded as high as $26 within minutes of opening, delivering a ridiculous price tag of $4.2 billion!

Today's hungry investors don't seem to mind that more than half of the shares are being offered by insiders, or that a good chunk of the proceeds are going right out the door to pay accrued dividends on convertible preferred shares that are being exchanged for common stock.

I'm guessing that most of today's investors aren't even aware that -- unlike traditional terrestrial radio operators -- Pandora has to shell out a growing percentage of its revenue to the record labels in the form of royalties.

Pandora is an attractive company, but not at today's highly unattractive pop.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

Liberty Capital (Nasdaq: LCAPA)
Pandora's lofty valuation makes Sirius XM Radio (Nasdaq: SIRI) seem cheap in comparison. Sirius XM is profitable and should generate more than $3 billion in revenue this year. Both companies face escalating percentages going out in music royalties in the coming years, but Sirius XM is now built to take on that future profitably. I do like Sirius XM, especially now that it has fallen under $2 with the recent market correction. However, Liberty Capital owns 40% of the satellite radio giant and trades at a discount to its portfolio of properties.

Apple (Nasdaq: AAPL)
The popularity of Pandora on Apple's iOS platform -- now with 200 million iPads, iPhones, and iPod touch media players in the wild -- may have helped put the music discovery site on the map, but Apple still owns the road. Apple's recent push to the cloud -- with iCloud, iTunes Match, and even last year's uninspired Ping rollout -- will make Apple a bigger threat to Pandora than it thinks.

Google (Nasdaq: GOOG)
Apple's not the only company crashing Pandora's stream dream. Google and (Nasdaq: AMZN) have recently hit the market with cloud-based music storage. Digital lockers offer ear candy on the go wherever wireless carriers or Wi-Fi hot spots can offer up connectivity, which happen to be the same requirements for Pandora. The arrival of Apple, Google, and Amazon in this space so quickly won't spell the end of Pandora, but it will give die-hard music listeners far more options after they've exhausted that 40th monthly free hour on Pandora. I also like Google's valuation here, priced at a mere 15 times this year's earnings and 13 times next year's bottom-line target.

I'm sorry, Pandora. This is one box that I don't want to open at this price.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Pandora Media, Inc. Stock Quote
Pandora Media, Inc.
Sirius XM Holdings Inc. Stock Quote
Sirius XM Holdings Inc.
$6.20 (-1.90%) $0.12
Alphabet Inc. Stock Quote
Alphabet Inc.
$2,945.39 (2.87%) $82.29
Apple Inc. Stock Quote
Apple Inc.
$171.18 (3.55%) $5.86, Inc. Stock Quote, Inc.
$3,523.29 (2.80%) $95.92

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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