At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about.
"Pandorum" at Pandora
|IMDb.com describes the 2009 cult classic Pandorum as a sci-fi movie in which "two astronauts awaken … aboard a seemingly abandoned spacecraft. It's pitch black, they are disoriented, and … they can't remember anything: Who are they? What is their mission?" Today, I wonder whether early investors in Pandora Media
Since IPO'ing one month ago at $16 and experiencing a brief but exhilarating price spike, Pandora shares have fallen steadily as broker after broker has piled on to criticize the company. So far, we've mainly seem non-brand-name analysts on the short side, like Albert Fried & Co., Gilford Securities, and BTIG. But we're steadily moving up in quality, as this morning an analyst from Capstone Investments also voted "nay" on the stock. So far, the company has managed to attract four "sell" ratings against just a single "buy." And that "buy" rating came from Maxim Group, literally one of Wall Street's worst analysts.
Pandora: boxed in?
What has Wall Street so dead-set against this stock? For one thing, the competitors Pandora faces threaten to kill it dead. Earlier this week, Albert Fried named competitive threats as Reason No. 1 to avoid Pandora.
Which threats, exactly? The Fool's own Rick Munarriz named names earlier this week:
Sirius XM Radio
(Nasdaq: SIRI), the leader in "premium coast-to-coast content."
- The "relaunch of AOL's
(NYSE: AOL)AOL Radio."
- iHeartRadio -- "one of music's more popular downloads on Apple's
(Nasdaq: AAPL)App Store since its 2008 rollout."
Pandora: No cash in the box
And just today, we learned of a new name, as European music service Spotify enters the U.S. market. Just what Pandora needed! More competition. Of course, lots of companies face competition. Come to think of it, if no one wants to compete for your business, it's probably not that profitable a business to be in. In that regard, having competition may actually be a good thing. What's less good, however, is how Pandora is facing up to the pressure.
Consider: After losing money and burning cash for years, Pandora made a superhuman effort to get its financials in order in time for last month's IPO. Net losses dropped from $16.8 million in the year ended Jan. 31, 2010, to just $1.8 million in fiscal year ending in 2011. Operating cash flow transformed from a negative $27.5 million to a positive $3.2 million in the blink of an eye. The timing was certainly convenient and probably helped the IPO, but already, Pandora seems to be returning to its old habits.
For the 12-month period that ended in April, Pandora has already dropped back to $5.5 million in net losses. Operating cash flow ratcheted back to $1 million, while capital expenditures leapt to $10 million -- leaving the company with net negative free cash flow of $9 million for the period -- its worst showing since fiscal 2009.
Pandora's valuation: a mystery packaged in an enigma
Yet despite simply awful numbers, Gilford Securities notes that Pandora carries an illogically lofty valuation of "36.8x FY14 EBITDA." It's going to take a while for Pandora to grow into that valuation even if everything goes well and the company grows as scheduled. But Gilford further points out that even growth may be a trap for Pandora: "Active users' robust double-digit growth boosts P's [advertising revenues]; however, it also boosts its stratospheric royalty fees." As the analyst notes, users listened to 111% more hours of Pandora content last year than in 2009 -- but "royalty fees were also up 111%."
So much for economies of scale.
Unprofitable and burning cash, Pandora isn't worth owning Pandora at today's prices, based on today's profits. And now, Gilford, Albert Fried, and all the rest and are telling us that tomorrow's prices might not be any better -- because Pandora cannot improve profit margins in the face of rising royalty costs.
Call me a skeptic, but based on what Pandora's done so far and what it seems likely to do going forward, I don't see any compelling need to own this stock. But how much do you want to bet that when Pandora's underwriters -- Morgan Stanley, JPMorgan, Citi, Stifel, Wells Fargo, and William Blair -- are released from their gag orders and become free to make recommendations, they'll come to a different conclusion? I'm guessing that with 16.9 million shares of Pandora stock underwritten by them collectively -- $270 million worth of their reputation on the line, and millions more in underwriting fees earned -- Pandora will find that the name-brand banks will be much kinder in their ratings next week.
My advice: Be prepared for a big stock-price bump when Pandora's underwriting "quiet period" ends on July 25. If your investing timeline is any longer than two weeks, however, it's probably better to leave Pandora in the box and seek profits elsewhere.
Fool contributor Rich Smith does not own shares of (or short) any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 565 out of more than 170,000 members.
The Motley Fool owns shares of Apple, and Motley Fool newsletter services have recommended buying shares and creating a bull call position on Apple.
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