Why The Bears Are Wrong About Pandora

| About: Pandora Media (P)

Pandora (NYSE:P) is the internet radio service people absolutely love, and the stock the bears love to hate. Why do people love the service? From Pandora's own corporate website:

Pandora... gives people music and comedy they love anytime, anywhere, through connected devices. Personalized stations launch instantly with the input of a single "seed" - a favorite artist, song or genre.

People have an affection for the service that rivals the most loved brands. The personalized musical content is a powerful hook. It is also interesting to note that entering a comedian's name as the "seed" works just as well as a musical artist; one of my favorite channels is "George Carlin radio."

Recent price activity

The stock has had quite a roller coaster ride over the past several months. It was trading along at about $9.50 a share on October 25, when reports that Apple (NASDAQ:AAPL) would be introducing a radio service in 2013 sent the price down more than $2.00. Over the next few weeks, the price partially recovered only to fall to new lows barely above $7.00. But gradually it recovered all the way back to $9.50 on December 4, the day of the third-quarter earnings announcements. The news from the company that afternoon was both great and terrible.

Fair warning!

Pandora is a tremendous growth story. In November, active listeners are up 45% to 62.4 million and listener hours are up 59% to 1.27 billion hours year over year. The company claims 74% of all internet radio listening. And other than Google (NASDAQ:GOOG), Pandora generates more mobile advertising revenue than any company on the planet. But the price is extremely volatile and will massively spike up or down based on real news or industry rumors. Not a stock for the faint of heart.

A surprising earnings call

The numbers were impressive for the fiscal third quarter -- ad revenue increased 61% to $106.3 million and revenue from subscribers was up 52% to $13.7 million. And of those ad dollars, the mobile revenue component was up 112% to $73.9 million. That was the good news. But the guidance for the fiscal fourth quarter was very different:

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.

What happened to Q4?

Ouch! Q4 was forecast to be effectively flat when the market expected continued growth. This immediately pushed shares down as much as 20%. CFO Steve Cakebread explained the lowered guidance on the earnings call:

What we've really experienced over the past couple of months is increasing caution from advertisers about macroeconomic concern, 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.

From Rich Tullo, analyst with Albert Fried & Company, "This is a conservative guidance issue. I think the (third quarter) numbers are strong. You can't argue with 112 percent growth on mobile."

Pandora is primarily an advertising-based company and any analysis needs to include a deep understanding of that industry. Most advertising campaigns end in December, and new budgets are allocated for January. If advertiser confidence is shaken for any reason, January can be a rough month for sellers of ad inventory. Combined with the fact that Pandora's fiscal reporting for Q4 is different than most media companies - November, December and January instead of October, November and December - means that the company's Q4 and full year is hyper-sensitive to poor January visibility.

It is very easy for someone not familiar with the advertising industry to discount Pandora's concern with January and advance his or her own theory of why the guidance was so conservative. One such idea is that competition with Apple's internet radio product is already reducing Pandora's ad revenue. But it's very hard to believe that a service reported as "far from a done deal" and no announced launch date is affecting media planning for the next month.

Why this is a bad time to be a Pandora bear
Amazingly, all the bad news is out and Pandora's stock price is right back to where it was before the pre-earnings run-up. However, the stock price could shoot upward should any of the following occur:

  • The macroeconomic "fiscal cliff" issues are resolved quickly or we receive other indications of advertiser confidence in the near future. Soon we'll have better visibility on the amount of media spend likely for January 2013. Positive signs in the industry could indicate that Pandora's Q4 guidance was too conservative.

  • HR 6480 moves forward in a beneficial fashion. HR 6480 is also called the "Internet Radio Fairness Act" and would provide Pandora a level playing field with respect to royalty fees, which are an inordinate amount of its ongoing expenses. An appropriate piece of legislation passing would have an immediate, immense and positive effect on the stock price.

  • Any news or rumor of acquisition interest. Pandora went public in June of 2011 at $16 per share. While most usage statistics have doubled since then (listener hours, active listeners, share of total U.S. radio), the stock currently trades at roughly half that IPO price. Potential interested companies could include Google, Facebook (NASDAQ:FB) and Amazon (NASDAQ:AMZN). Pandora provides links to buy songs on iTunes and Amazon, and is a huge referrer to each company.


Those who bet on Pandora's stock price going down were rewarded with a great opportunity to close out their positions after the Q3 earnings announcement. However, if January's revenue visibility wasn't clouded by macroeconomic issues, the strong Q3 results coupled with a more normal guidance for Q4 would have instead propelled the roller coaster upward.

Pandora is still a growth story still in the early stages of monetizing its huge user base. In the future, there will be plenty of gyrations in the stock price, both up and down. But for now, the downside news is out and factored into the current price. Any upside news will provide a great opportunity for shareholders. It is a bad time to be a Pandora bear.

Disclosure: I am long P. 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.