Pandora Continues To Disappoint

| About: Pandora Media (P)

Another day, another disappointment for Pandora (NYSE:P) and its investors.

Upon releasing earnings for Q3, Pandora shares were slammed in after hours trading, dropping over 20%, and down $2 per share from the day's close of $9.45. At first glance, earnings appeared positive, with EPS coming in at $0.05 per share, beating estimates by $0.04. But that was about the only ray of sunshine left before looming dark clouds of future guidance rolled in and cast the company in shadow.

Dramatic? Perhaps, but I believe Pandora's guidance for Q4 speaks for itself.

From Seeking Alpha's market currents:

FQ4 guidance is for revenue of $120M-$123M and EPS of -$0.06 to -$0.09, below a consensus of $130.3M and $0.02.

4 cents positive one quarter, and then 8 to 11 cents negative the next does not result in a net positive. What was the reasoning behind this disturbing guidance?

Joe Kennedy explains:

What we're really seeing from advertisers, I think has to be first understood in the context of again our Fiscal Year quarter is November December and January and so what we really experienced over the past couple months is increase in caution from advertisers about macroeconomic concerns, the fiscal cliff particularly in January, and that really is the difference between what we know now and what we knew three months ago when we last gave guidance. The visibility of January is never particularly good and the cautiousness surrounding January at this point further deteriorates the visibility and drives us to a more cautious position. As you suggest, November and December are seasonally strong months and we certainly expect a good November and December but are very cautious about January at this point.

Essentially, Pandora is exercising caution about January, citing that advertisers may be seeking to cut back on spending after the first of the year due to potential effects of the fiscal cliff. Really? One month out of the quarter, some advertisers may cut back due to the potential of the fiscal cliff, and Pandora may come in so far below analyst estimates? Is Joe being honest with us here?

Consider the following from Reuters:

"I think the key issue here is that Pandora is facing increased competition in mobile," said Richard Greenfield, an analyst with BTIG.

"It's easy to just blame fiscal cliff. The shares fell because they are missing numbers."

Michael Pachter an analyst with Wedbush Securities said, "Essentially they are not getting as much advertising revenue as before."

Pachter added that he doubts advertisers are really snapping shut their purses because of the fiscal cliff.

If you have not read them before, take a moment to read some of my articles on Pandora. Pay close attention to the three most recent articles, and finish up with my article about the Internet Radio Fairness Act. There should be a wealth of information on pitfalls there that, quite honestly, make the negative effects of the fiscal cliff seem pretty weak.

If it is not clear by now, Pandora faces some extremely strong headwinds and Tuesday's conference call has shown how just one thing going "not quite right" can have a dramatic impact on Pandora's business model. It does not matter if advertisers may be pulling back due to the potential of the fiscal cliff. The fact is that advertisers may pull back for any number of reasons, and with Pandora balancing so close to the edge on profit and loss, the company simply can not afford any pullback in revenue.

Why? Because the company continues to grow its user base at a good clip. I can certainly understand why. The company provides a nice service that many people enjoy, and provides it for free. The problem here is that when Pandora gives away what it pays for for free, more people come to it with their hands out. This means it starts to bleed money unless it can continue to monetize the user base through increased advertisement revenue. Users are growing, advertisers potentially cutting back, and there's royalty rate of $0.0011 per song play, set to rise soon to $0.0012 per song play.

That's a serious problem. Less revenue, more expenses, and quite honestly, no relief in sight for the immediate future.

When looking at these things it is not surprising that Pandora is currently crying to congress about what it deems are "unfair" royalty rates. It's understandable, but it should be viewed by investors as a huge red flag that a quick exit should be in order. Even Pandora's well known number one cheerleader, Rocco Pendola, turned bearish on the company once artists rallied in opposition to Pandora and the Internet Radio Fairness Act.

Now, I simply cannot be a bull unless Pandora makes profound changes to its approach in the fight over music royalties.

Here's why I am worried.

On Thursday, a large collection of musicians -- about 125 of them -- signed an open letter to Pandora opposing the Internet Radio Fairness Act.

Even Rocco Pendola can understand that angering artists is not the right path to take in this matter.

The fact of the matter is, folks, that Pandora is a wonderful service that many people enjoy, but it is a very poor investment. From IPO to today, the share price has followed a straight trend down, and I would not be surprised to see share prices continue to find lower lows in the coming sessions.

Advertising only works if you can secure enough of it, at a high enough rate. Pandora seems unable to do either of those things, and without the strong and consistent revenue stream provided to subscription based services like Sirius XM (NASDAQ:SIRI), Pandora is going to struggle. When you consider that Sirius XM pays nearly $1 per user per month in royalties, and Pandora pays only about $0.27 per user, the problem isn't royalties, it's the monetization of the user base. Until or unless Pandora can get its users to cough up some cash to help pay for content, the company and share price will likely suffer due to the poor business model.

So feel free to enjoy Pandora for some tunes, but by all means stay away from the stock.

Disclosure: I am long SIRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.