Follow The Leader: Pandora's Analyst Upgrades

Nov.17.13 | About: Pandora Media (P)

'Follow the Leader' is a game that is often played in the stock market by retail investors. Sometimes it is based on prudent considerations. When Carl Icahn, several months ago, disclosed his stake in Apple (NASDAQ:AAPL) via Twitter, the market capitalization of Apple spiked by billions as retail investors, aware of Icahn's brilliant record of activist investing, poured their money into Apple before the buybacks began. At other times the Follow the Leader game takes more peculiar forms, less based on substantive reasons about what the ordinary investors think that the Leader will do, and more based on their trust in the sheer fact of the Leader's expertise. I propose that the sudden run-up in Pandora stock during the last week is in part attributable to a variation of the Follow the Leader game.

Pandora (NYSE:P), as of the writing of this article, is up over $4.50 in the last week. This is an extraordinary increase. To my knowledge, no new statistics or listener metrics have been released by Pandora or by independent parties. So there has been no substantive information that has emerged and altered the nature of a Pandora investment. Instead the spike seems to be attributable to four things: (1) analyst upgrades, (2) a short squeeze, (3) hedge fund disclosures, and (4) a general advance in the tech sector.

1) As for the first, at least two different firms have issued bullish notes about Pandora ahead of its FQ3 report on November 21. Needham led the charge, as analyst Laura Martin raised her price target for Pandora from $25 to $33. Martin also increased her FY14 and FY15 estimates about Pandora's performance. The reasoning used by Martin, as reported by SA is that "Martin sees the Web/mobile radio leader posting FQ3 results that are better than prior estimates, and expects the company to continue its momentum in subsequent quarters." Also raising its price target was J.P. Morgan, from $25 to $35. It declared, as reported by SA, that "the Internet radio leader is nearing a revenue 'inflection point' thanks to share gains and salesforce investments."

Whether or not these upgrades are sincere - and perhaps they are - the problem is that they appear, at least on the surface, to be highly dubious. In particular they appear to be a cynical effort on the part of these two firms to leverage their expert status (or perceived expert status) for the sake of improving the pre-earnings stock price. Both firms are underwriters for the recent secondary share offering, which, as I mentioned in an earlier SA piece, means that "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." As such, the shares of these two firms in the secondary offering are locked up until mid-December. Other firms are involved in the underwriting as well: "The bookrunning managers of the proposed offering will be J.P. Morgan and Morgan Stanley. Wells Fargo Securities, BofA Merrill Lynch, BMO Capital Markets, Canaccord Genuity, Needham & Company, Pacific Crest Securities, Piper Jaffray and William Blair will act as co-managers." The average retail investor certainly does not know all of this about the allegiances of these firms because such information is not usually disclosed in the short news blurbs which report the analyst upgrades.

2) The analyst upgrades, because of the high percentage of Pandora shares that are sold short, have initiated a short squeeze. I am a Pandora bear, and the time for bears like me to be cautious about a short sale on a particular security is when two things coalesce: (1) the short percentage on a particular security is especially high - higher than is commonplace among peer securities, and (2) the volume of trading that surrounds that security is not particularly high, whether because of an absence of day traders, a lack of interest in the security among investors, a small market cap, or other reasons. The idea here is that the security in question is immensely more likely to undergo a short squeeze when its days to cover ratio is high (where days to cover is the number of days that it would take for all shorts to cover their positions by buying the stock). I do not know the percentage of Pandora's share total, as of today, that is sold short. But I can say that it has in recent weeks been very high - so high that at times it has not been possible to short the stock directly, and bears have been forced to purchase puts. So the days to cover ratio has in all likelihood been a dangerous one for short sellers. The setup has been perfect for the Needham and J.P. Morgan analyst communities to initiate a short squeeze.

3) Much more sincere than the analyst upgrades have been the recent hedge fund disclosures. Coatue Management and Tiger Consumer Management have both disclosed large share positions in Pandora - Coatue Management's 1.1 million shares and Tiger Consumer Management's 2.9 million shares. If someone is intent on playing the Follow the Leader game, hedge fund disclosures of this kind are much more trustworthy than the analyst upgrades of Needham and J.P. Morgan. The latter involve no change in the extent of the financial involvement of the firms - just a change in their speculation about Pandora's PT.

4) There has, in addition, been a general run-up in the tech sector in recent days which does in part seem to be responsible for Pandora's rise. In part as a result of Sina's surprisingly good Q3 performance, names like Yelp (YLP), Linkedin (NYSE:LNKD), Twitter (NYSE:TWTR), Zynga (NASDAQ:ZNGA), Angie's List (NASDAQ:ANGI), and so forth have all seen advances. So Pandora seems to be improving in part out of sympathy to its peers.

To be sure, I readily admit that I am a Pandora bear and that my judgment about the nature of these analyst upgrades is being influenced by my overall perspective about the future of Pandora. As evidenced by my disclosure above, I do have a personal stake in a Pandora decline. And I am happy to admit that my bearish perspective, as I mentioned in my earlier SA piece, might be wrong. But if I were on the other side of things - if I were a Pandora bull - I can say with certainty that I would not under any circumstances put more money into Pandora on the basis of analyst upgrades that are as dubious as these. Hedge fund disclosures are much of the time trustworthy things if one is playing the Follow the Leader game. But the Follow the Leader game is sometimes a dangerous exercise. It can quickly grow expensive if you happen to be the last stockholder to a party that has been artificially manufactured by analyst upgrades.

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.