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Shares of Pandora Media (P) fell up to 18% in after hours trading. The internet radio company reported its third quarter results of its fiscal 2013 after the market close on Tuesday.

Third Quarter Results

Pandora reported third quarter revenues of $120.0 million, up 60% on the year before. Growth was driven by mobile revenues which rose 112% to $73.9 million. Revenues beat analysts consensus of $117 million.

Pandora generates the majority of its revenues from advertising, for a total of $106.3 million. This is up 61% on the year before. Subscription revenues rose 52% to $13.7 million.

The total number of active users rose 47% to 59.2 million. In total, users listened 3.56 billion hours during the quarter, which is up 67% on the year before. On average, users listened over 60 hours of radio during the quarter via Pandora.

Pandora reported non-GAAP diluted earnings per share of $0.05, beating analysts consensus by a penny. GAAP earnings per share came in at $0.01 per share. Net income on a GAAP basis roughly tripled to $2.0 million.

CEO and Chairman Joe Kennedy commented on the results, "This quarter exceeded our expectations as we monetized mobile at record levels and grew total mobile revenue 112%. During the quarter we launched Pandora 4.0, the biggest redesign on the iOS and Android platforms ever, bringing new, innovative and enhanced functionality to mobile devices for the first time for both users and advertisers."

Outlook

For the fourth quarter of its fiscal 2013, Pandora expects revenues of $120-$123 million. Non-GAAP losses per share are expected to come in between 6 and 9 cents. Analysts expected that Pandora would guide for non-GAAP earnings of $0.01 per share.

The outlook implies that revenues will come in flat, or rise by a mere 2.5% between the third and the fourth quarter.

Full year revenues could come in between $422 and $425 million. Annual non-GAAP losses per share are expected to come in between $0.09 and $0.12 per share.

Valuation

Pandora ended its third quarter with $80.5 million in cash, equivalents and short term investments. The company operates without the assumption of debt, for a net cash position of roughly $80 million.

For the first nine months of 2012, Pandora generated revenues of $302.1 million. The company net lost $23.6 million for the period.

Factoring in a 18% decline in Pandora's share price after the market close, the market values Pandora at roughly $1.3 billion. This values operating assets a little over $1.2 billion. Operating assets are valued at roughly 2.9 times annual revenues.

Some Historical Perspective
Year to date, shares of Pandora have fallen some 20%. Shares started the year around $10 per share and rose to $15 in March. Shares hit lows of $7 in November and rose to $9.50 during the regular trading session on Tuesday. Shares are exchanging hands at $7.75 per share in after hours trading.

Pandora went public in June of last year at a price of $16 per share. Shares peaked at $20 in the weeks after the offering, and are currently trading at the lowest levels after going public. Over the past years, revenues of the internet radio company grew its revenues from merely $19.3 million in 2009 to an estimated $425 million this year.

Investment Thesis

While third quarter performance was in line with expectations, investors are disappointed by the poor guidance for the fourth quarter. CEO Kennedy notes that additional investments and hiring of local radio staff will impact profitability in the fourth quarter. The company guides for losses, which are far surpassing analysts expectations. Revenue growth is disappointing as well, with flat to very low revenue growth on a quarterly basis.

In recent times, the company has been facing two major issues:

First of all, royalty payments are sky high and increased listening hours per user impact Pandora's bottom line. The radio company pays royalties per individual song. "Content acquisition costs" comprised 54.8% of total revenues during the quarter, which compares to 50.2% in the third quarter of fiscal 2012. Ironically, the success of Pandora is actually costing the company a lot of money. It is difficult for the company to boost advertising revenues as many listeners switch to smart phones.

By transforming royalty payments from a fixed payment into a percentage payment, Pandora would be able to change the business model from a fixed costs base into a variable costs base. This would result in positive sales leverage for Pandora in the future. In the short term no verdict is expected.

Second, Pandora might face competition from Apple (AAPL) which might make an entry in the online radio market, as widely rumored. Supposedly, the company might initiate a radio service which could directly compete with Pandora. Apple's expertise in the online music industry is widely known, given the success of iTunes which transformed the way consumers downloaded their music over the past decade.

In August of this year I took a look at Pandora's prospects. At that point in time I remained on the sidelines, and I will reiterate that stance at the moment. A poor guidance, the threat of a strong competitor entering the market, and uncertainty about royalty payments, are plenty of reasons to remain on the sidelines.

Source: Pandora - Shares Retest Lows After A Very Poor Guidance