It's certainly been a there-and-back-again year for shares of Internet radio player Pandora Media (NYSE: P).
After rallying to unjustifiable heights in 2013 and early 2014, reality caught up with Pandora's stock price in the early spring of last year. Peak to trough, Pandora's stock then proceeded to plummet from $37.24 in late February to $13.30 by mid-July. More recently, Pandora's shares have been on the up-and-up as a number of positive developments have finally provided investors room for optimism, including a meaningful positive in its ongoing royalty rates case.
The right side of the rights ruling
Last week, Pandora's stock was temporarily halted from trading, presaging the subsequent confirmation by Pandora that it had received a positive initial ruling from the U.S. Copyright Office as part of its ongoing royalty rates case. The news sent Pandora's shares as much as 14% higher during intra-day trading.
For those unfamiliar with this narrative, Pandora has argued it possesses the right to use its agreement with digital rights agency Merlin as a benchmark in its ongoing hearing with the U.S. Copyright Royalty Board, a panel of three judges. Although neither Pandora nor Merlin have publicly disclosed the royalty rates their agreement states, it's widely believed the agreed-upon rates cost less than the royalty agreements Pandora currently pays, which could help improve the underlying economics of Pandora's present high-cost business model.
Source: Pandora Media.
To be clear, this news is not a final ruling, although it certainly indicates the likely direction the U.S. Copyright Royalty Board will rule. The final decision is expected no later than Dec. 16 and will determine the royalty rates Pandora and other Internet radio firms pay from the start of 2016 through the end of 2020.
But does this man Pandora a buy?
Cleary, this news improves the likely trajectory for Pandora's long-term cost structure. But at the same time, I'm not necessarily convinced this news alone is substantial enough right now to make Pandora a buy for a few key reasons.
Remember that expanding Pandora's financial footprint rests on not only improving its cost structure but also on increasing its user base. Pandora largely relies on ad revenue as its primary source of funding, so it can grow its top line by either adding more users or expanding the amount of time each listener uses the service. As there are only so many hours in the day, growing average user hours streamed has somewhat of an upper limit.
For context, Pandora has managed to increase the average hours streamed per user from 4.3 hours to 5.3, which allows it to generate more ad revenue per user. However, in order to justify its valuation, Pandora will also have to continue to grow its user base, which has slowed to single-digit growth over the past two years.
Unlike better-positioned streaming services like Apple Music and Spotify, which can expand internationally, Pandora remains constrained within the U.S. and a handful of ancillary markets due to its unique music licensing model. So in terms of still being a "growth story," I question whether the moniker really applies to Pandora. That's not the only problem, though.
Turning to valuation, I'm similarly skeptical that Pandora shares offer much observable value, even considering the likely financial tailwind from a favorable rights ruling. As it has never consistently achieved profitability, Pandora currently lacks a bankable price-to-earnings ratio, which is admittedly a backward-looking metric. However, even turning to a forward-looking valuation tool like PEG ratio, Pandora sports an alarmingly high 50.9 times valuation, with the above growth constraints looming especially large in hindering Pandora's odds of making good on its generous valuation.
So, while I congratulate Pandora and its shareholders for their likely victory and the benefits it will yield, I still think potentially investing in Pandora carries more risks than potential benefits, still making it an easy pass in my book.
