A brief glance at some recent SA articles suggests that the great majority of SA authors and readers expect Pandora's (NYSE:P) metrics and eventually its stock price to fall in the near future. Most seem to think that the fall will occur within the next 6 months or so. I too agree with this thesis. But as an investor I know also that it is always prudent to consider the other side of the story. Certainly Pandora did not achieve its status as an industry leader by means of a business strategy that involved rolling over and capitulating in the face of the competition. Here, then, are some possible options that Pandora management might be considering as they seek to compete with Apple's (NASDAQ:AAPL) iTunes Radio and also more generally in the increasingly crowded sector of Internet radio services. Prudent investors should, I think, keep their eyes and ears open in the coming months to determine if Pandora is indeed pursuing one or more of these options, and whether or not Pandora's pursuit of such option(s) is likely to do much to help it to maintain its existing status as an industry leader.
1) Expand the audience. This is, I think, one of Pandora's most likely strategies. Currently Pandora has about 3 million paying subscribers and 71 million non-paying listeners in the U.S. Although the internet streaming sector is rapidly expanding and taking market share away from traditional radio, nevertheless, companies like Pandora might, along with other industry leaders in the internet streaming business, sometime in the next couple of years be approaching saturation levels in the U.S. Pandora does not offer services right now outside of the United States, Australia, and New Zealand. Immediate options that come to mind - countries whose peoples are used to listening to the kind of music options that Pandora offers, and whose licensing processes are likely to be similar to the licensing processes with which Pandora is familiar, include the United Kingdom, France, Germany, the other Western European countries, and perhaps South Africa. Of course, Pandora would in these countries face similar competition from Apple and other streaming services. So to get away altogether from its competitors it would probably have to look to the developing world. This is doubtful because there are not nearly as many mobile users in countries outside of the G8 (or even the G20), and mobile has been the most promising area of user expansion for streaming services like Pandora in recent years.
To expand into other countries and markets will of course require navigating the music licensing requirements and fees of these other settings. But Pandora's current cash position does seem to put them in an advantageous position to do this. Pandora is sitting on a pretty large cash pile right now, having sold, in a recent secondary offering, 15.73 million shares at $25 per share. Certainly the company's management has been prudent in preparing for the fight with Apple by improving its cash position through an offering at its current expensive share price (trailing P/E of 903, forward P/E of 103). The large amount of cash that is available gives management more options when it comes to finding new markets and improving its existing offerings.
2) Increase advertising revenue by advertising in more effective ways and also more often to their existing listeners. As for effective advertising, Pandora does a good job right now of pursuing local advertising targeting. Pursuing an even more localized strategy might in the coming months be an especially good option. Moreover, mobile RPM has increased from $21.05 to $22.53 in the last two years. So this is a particularly promising option for targeting those listeners who access Pandora by means of their mobile devices. Another reason why this second option is promising is that it would not be as expensive as some of the other options that Pandora is facing. It is not, for instance, as expensive as expansion into other countries - which requires new licensing fees, etc. Attracting new advertisers is not all that expensive a proposition, although the company would need to be able to demonstrate to the advertisers that their efforts would be effective. Of course, the downside of this second option is that increasing its advertising rates will also have the negative effect of driving some listeners away to Xbox Music, Rhapsody, ITunes Radio, Sirius Satellite Radio, Spotify, Songza, and so forth. This is especially true if Pandora's competitors do not also in the coming months pursue a policy of increasing their revenue through an expansion of their advertising efforts.
The big issue when it comes to advertising rate increases is the stickiness of the Pandora interface. Much has been made of this issue in the recent investment literature, but not many people seem to know how sticky the interface in fact is in practice. Pandora itself does not provide information about its churn rate. Do users prefer to stay with their tried-and-true music services? Are users opening multiple accounts with different streaming services and switching among them as needed? No one seems to have steady statistics on this metric. Competitor Sirius FM's churn rate is something like 1.7 to 2% per month. Part of the issue with churn rate is, I think, the demographics of Pandora's audience. I am particularly curious to know what the age demographics are of Pandora's audience, but I am not sure right now how to go about determining this information. Age demographics matter in this equation because younger listeners are, I think, more likely to be internet savvy and to be willing to set up different music streaming accounts with Pandora's competitors - or, alternatively, more willing to switch among multiple different streaming services. At any rate, if Pandora's advertising were to increase, some listeners would of course reconcile themselves to the advertising increases and would continue to listen to Pandora. Others might stir themselves to set up an account with other streaming services.
3) Increase the size of its music library. A common criticism of Pandora among bears is that its music library is a fraction of the size of the music libraries of its competitors. As of last month, Pandora had about 1 million songs in its library, in comparison to iTunes Radio's 27 million. And Pandora's large current cash position ought to give it a significant amount of leverage for the purchase of music licensing fees and processing the other logistical fees which it could navigate a music library increase. Of course, increasing the size of its music library might take a significant amount of time to sink in among listeners. It might take a while - months, perhaps - for users to realize to a degree that would alter their listening habits that their song options at Pandora are increasing.
4) Decrease its exposure to Apple products by marketing especially aggressively to Android and Samsung users. ITunes Radio is of course more accessible to users of the iOS 7 system and of Apple products in general, so it would of course make sense for Pandora to pursue this strategy in response to Apple. Currently about 40-50% of Pandora's user base is made up of Apple users.
5) Hunker down, use its cash pile for general leverage purposes, and hope that the existing Pandora music interface is sufficiently sticky to keep existing listeners attached. This option is possible, although not likely, because of the ease with which it is possible for listeners to set up accounts with other music service providers. At the same time, it is true, however, that the overall listener base for streaming services is increasing at this time. So this strategy might be a possibility because the pie is getting bigger for Pandora, iTunes Radio, and everyone else in the streaming business. The current audience metrics and trends over the last several months, listed below, do not appear to be particularly promising for this sort of a route.
TOTAL LISTENER HOURS TRENDS OF 2013:
- Listener hours for Pandora October 2013 were 1.47 billion, a year-over-year increase of 18% from 1.25 billion.
- For September 2013 they were 1.36 billion, an increase of 18% from 1.15 billion.
- For August 2013 they were 1.35 billion, an increase of 16% from 1.16 billion.
- For July 2013 they were 1.28 billion, an increase of 14% from 1.12 billion.
- For June 2013 they were 1.25 billion, an increase of 17% from 1.08 billion.
- For May 2013 they were 1.35 billion, an increase of 22% from 1.10 billion.
- For April 2013 they were 1.31 billion, an increase of 24% from 1.06 billion.
- For March 2013 they were 1.49 billion, an increase of 40% from 1.07 billion.
- For February 2013 they were 1.38 billion, an increase of 42% from 975 million.
TOTAL MARKET SHARE FIGURES IN 2013:
- Share of total U.S. radio listening for Pandora in October 2013 was 8.06%, a year-over-year increase from 6.61%.
- In September 2013 it was 7.77%, an increase from 6.53%.
- In August 2013 it was 7.46%, an increase from 6.30%.
- In July 2013 it was 7.08%, an increase from 6.13%.
- In June 2013 it was 7.04%, an increase from 5.98%.
- In May 2013 it was 7.29%, an increase from 5.80%.
- In April 2013 it was 7.33%, an increase from 5.95%.
- In March 2013 it was 8.05%, an increase from 5.73%.
- In February 2013 it was 8.48%, an increase from 5.74%.
TOTAL NUMBER OF ACTIVE USERS IN 2013:
- Active listeners were 70.9 million at the end of October 2013, a year-over-year increase of 20% from 59.2 million.
- They were 72.7 million at the end of September 2013, an increase of 25% from 58.3 million.
- They were 72.1 million at the end of August 2013, an increase of 28% from 56.2 million.
- They were 71.2 million at the end of July 2013, an increase of 30% from 54.9 million.
- They were 71.1 million at the end of June 2013, an increase of 30% from 54.5 million.
- They were 70.8 million at the end of May 2013, an increase of 33% from 53.3 million.
- They were 70.1 million at the end of April 2013, an increase of 35% from 51.9 million.
- They were 69.5 million at the end of March 2013, an increase of 36% from 51.2 million.
- They were 67.7 million at the end of February 2013, an increase of 37% from 49 million.
Source: Yahoo! Finance
Something else that could happen
Finally, bearish investors who are short Pandora should also note that another thing that could happen in the coming year to Pandora - although not, to be sure, an option that is being considered by management - is that if the company's share price does fall its large base of 70+ million users might make it an attractive takeover target to interested competitors. This is especially true if it turns out in the next few months that the Pandora interface proves to be stickier for existing users than a lot of analysts are supposing - and if the pile of 70 million users does not decline by all that much. A sufficiently large offer for the company by a competitor might have the same effect on the share price as a successful execution by Pandora management of one of the strategic options that I have listed above. This outcome would probably not be likely, however, unless the share price falls by a significant amount. At its current market capitalization of 4.7 billion Pandora is incredibly expensive and it is doubtful whether its Intellectual Property or genome holdings would be sufficiently valuable to be attractive to a possible buyer.
At any rate, the chief reason why I am short Pandora is because, like the other bubble stocks of this past year, it is now trading at 8 times sales and almost 50 times book value - the kind of valuation that seems absurd and that suggests, in the current conditions, a drop sometime in the near future.
Disclosure: I am short 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.