Even in the face of intense competition, Pandora Media (P) has remained the undisputed leader of the Internet radio market. The company claims 75 million monthly active users and roughly 9% of all U.S. radio listeners. But for a company in such a dominant position, it seems strange that Pandora is unable to turn a profit. The problem is that Pandora doesn't control its content, and that means Pandora has no competitive advantage beyond its size to speak of. Competition will eventually bring Pandora's stock price back to reality, and two recent developments from Google (GOOG -1.10%) (GOOGL -1.23%) and Amazon (AMZN -2.56%) may hasten that process.
Google buys Songza
Google's first attempt at a subscription music service, Google Play Music All Access, hasn't made much of an impact. The service cost $9.99 per month, making it more expensive than Pandora's subscription service and the same price as Spotify's, but it didn't really bring anything new to the table. There was little reason for Pandora or Spotify users to switch over.
Google plans to use the recent acquisition of Songza, a company that uses data along with curation by music experts in order to match music to listeners, to bolster its music offerings. Songza claims about 5.5 million users, far fewer than Pandora, but it's the curation that Google was likely after. While Songza will continue to operate as-is, Google will look to integrate the technology into both Play Music and its upcoming YouTube music streaming service.
Google getting serious about music is the last thing Pandora needs. YouTube is already enormously popular for videos, and its huge user base will be an asset when Google eventually launches its subscription service. Songza will help provide differentiation to Google's music services with something that Pandora and Spotify can't match. Whether that will be enough to pry users away from those services remains to be seen, but Google certainly isn't giving up.
Prime Music is a headache for Pandora
Amazon's recent foray into music streaming, Prime Music, isn't really anything impressive or different. Prime Music doesn't offer anything that other streaming services don't offer, but the key difference is that Prime Music is free for all Amazon Prime members. For the 20 million or more Amazon Prime members that have access to the service, unlimited streaming of over 1 million songs is both ad-free and included in the membership.
Amazon announced some information about the performance of the service after the first week, claiming that members have streamed tens of millions of songs. Exact numbers weren't given, but it's safe to say that millions at least tried out the service during that first week. While Prime Music is limited in its reach, any Pandora users that are also Amazon Prime members now have a very good reason to ditch Pandora entirely. Prime Music could very well lead to the defection of millions of Pandora users.
Why Pandora is grossly overvalued
There are two questions that anyone thinking about investing in Pandora need to ask. First, will Pandora ever be profitable? And second, will it be profitable enough to justify the current $5 billion price tag?
The answer to the first question: maybe. Pandora doesn't control any of its content, and that means it's relatively easy for a competitor to offer a very similar service. Netflix began creating its own shows for exactly this reason, to avoid being completely dependent on the ever-rising costs of licensing third-party content. Pandora was a first-mover in the market, but the advantage gained from that is not perpetual. There are no switching costs for consumers, and there's very little keeping Pandora users from leaving. This leads to the conclusion that it will be very difficult to consistently turn a profit as a stand-alone music streaming company. This also answers the second question: almost certainly not.
Pandora is valued at about $66 per monthly active user. Its subscription service brings in $60 per year per user, but this represents only a small fraction of the user base. The rest use the free version supported by advertisements. As a comparison, Google reportedly paid $39 million for Songza, although the exact number is not known. This values Songza at just $7 per user.
Pandora would need net income in the hundreds of millions of dollars to justify the current market capitalization. Pandora lost $27 million on revenue of $600 million in 2013, so the company needs to not only continue to grow revenue extremely rapidly, but it also needs to figure out how to turn a profit in the first place. And considering that Pandora's monthly active users have started to decline, with 75.3 million monthly active users in March compared to 76.2 million at the end of 2013, neither one of these seems very likely.
The bottom line
Competition will, sooner or later, dethrone Pandora. The stock is grossly overvalued, especially given that active user numbers have started to decline, and the company has no competitive advantages in an industry where heavyweights like Google and Amazon are entering the fray. It's only a matter of time before it becomes clear that Pandora as a stand-alone company doesn't make any sense. An acquisition is possible, but not at the current inflated stock price, so those buying Pandora in the hopes that a big tech company will snatch up the music streamer may want to reconsider.
