If you've ever wondered what rock bottom might look like, you might want to try Pandora Media (NYSE:P) on for size. The leading streaming-music platform was downgraded by a Wall Street pro yesterday, and it still managed to close 5% higher on the day.
Before we get into how freaky that is -- and how encouraging it may be to those long Pandora stock -- let's go over the long way down before yesterday's pop.
Pandora went public at $16 five years ago. The stock went on to peak north of $40 three years later, but the past two years have been cruel. Pandora lost a third of its value in 2014, another quarter of its value last year, and it's now trading 79% below its all-time high as of yesterday's close.
Wall Street has soured on Pandora, and analysts have been routinely downgrading the stock. With content costs inching higher and the competition getting smarter, it's not easy to recommend the purchase of the stock.
This brings us to yesterday morning, when Cowen & Co. lowered its rating on the stock from outperform to market perform, slashing its price target from $21 to $9 along the way. Cowen & Co.'s cautious stance is based on the fear that advertising revenue will take a hit as a result of Apple (NASDAQ:AAPL), Spotify, and others storming its turf. What does the competition have to do with Pandora's ability to generate ad revenue? Well, the fear here is that Pandora will reduce the number of ads that it makes its free subscribers hear so it doesn't lose them to Apple Radio. Reducing the ad load may make it more appealing to listeners, but naturally it will come at the expense of its top-line growth.
That's a problem. Most of Pandora's growth has come from the ads that it serves to its freeloaders because only a sliver of its listeners pay to eliminate the commercials as premium subscribers.
Pandora is set to report quarterly results after today's market close, but we can pull up October's third-quarter results to see that ad revenue accounted for 82% of the period's total revenue. With revenue growing faster than actual usage, a lot is riding on the ads that Pandora is serving. If it has to reduce the number of ads that its listeners will tolerate -- and it can't command higher rates from surviving sponsors -- it's going to be a problem.
Then we get to the market's surprising reaction to the downgrade. Pandora stock did open lower yesterday on the analyst move, but it reversed fairly quickly. The stock ultimately rose 5.4% on the day. That has to be pretty encouraging to shareholders for a stock that has been clobbered before on news that doesn't on the surface seem as bad as a once-bullish analyst losing faith in Pandora.
The real test will come after tonight's report, of course. This will be Pandora's second quarter competing against Apple Music, something that resulted in a sequential dip in active listeners the first time out. Then again, if the stock took off following an analyst downgrade on Wednesday, investors probably shouldn't be surprised if the stock moves higher if its fresh financials prove disappointing.
Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple and Pandora Media. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.