As I sit here and type this article, I'm listening to my iTunes library on shuffle. It costs me nothing, (besides the price paid to acquire it in the first place) I know I'm only getting songs that I like, there's no commercial interruptions, and I never run into buffering or network issues. I paid a considerable sum to acquire the almost 2000 songs in my collection, so I listen to it whenever I get the chance. Sometimes I listen while I work on my laptop, other times I'll plug my iPod or iPhone into my car's stereo.
Rather than talk about my music consumption patterns, let's take a look at Pandora (P), the internet based music streaming service. Since its IPO in June, 2011, the stock has performed well, doubling in price to today's value of $29, even though the company has only managed one profitable quarter in that time, and it was so close to break even that it barely counts.
Based on excessive valuations, the company having no competitive advantage, and increased competition, I believe Pandora is a strong short candidate at these high levels.
As I mentioned, Pandora currently isn't profitable. Yes, they technically made a profit on their last quarter, and did make a tiny operating profit during last year's 4th quarter, but they're still essentially a money losing company at this point.
Revenues are growing nicely, but this growth will slow as increased competition starts to take their toll on Pandora's growth and listeners start to migrate to other offerings (particularly Apple's iRadio service, which is still in its infancy).
We have a company that isn't profitable, only has cash because of a secondary stock offering which is allowing insiders to unload an additional 4M shares, and is trading at 116x 2015's projected earnings of $0.25 per share.
Pandora also has to pay a significant percentage of their revenue just to get content. The last quarterly report states the company paid approximately $60M (on revenues of just over $100M) just for the music rights. Satellite radio pays 9% of revenues, while traditional radio pays around 1%.
Because so many of the company's users stream music to their smartphones, carrier data costs make even free listening costly, as outlined by another Seeking Alpha contributor.
Much like Tesla (TSLA), Pandora is ultra sensitive to earnings misses. They last reported results on August 22nd, and a slight weakening of guidance sent the shares reeling, falling some 15% the next day. The company next reports earnings on November 21st, and according to Yahoo! Finance, analysts expect a profit of 4 cents per share.
One of the risks in shorting Pandora at these levels is the chance they can have a blowout quarter that'll send shares skyward. I think this is unlikely because of competitive risks from iTunes Radio and others, but it still remains a risk.
Apple (AAPL) launched iTunes Radio on September 18th, the same day they launched iOS7. The effect on Pandora was immediate, as they announced on November 5th that they lost 1.8M users compared to the previous month, dropping to 70.9M active users.
Like Pandora, iTunes Radio has both a free (ad supported) version and a paid premium version. Pandora's premium version is $36 a year (or $4 a month) and allows users more skips, higher listening quality, the ability to download a desktop portal, and the removal of the ads. For $25 a year, iTunes Radio takes away all the ads and allows an user access to their iTunes library via the cloud, something Pandora just can't offer. iTunes doesn't need to offer a free desktop portal since most people have already downloaded iTunes. Additionally, iTunes Radio offers unlimited skipping for both free and paid users. iTunes Radio is clearly the better value for consumers.
Apple isn't the new only player in this area. Both Google (GOOG) and Microsoft (MSFT) have introduced similar services recently, the Play Music and Xbox Music services, respectively. Songza is another completely free service which only has one ad when you launch a station, and they'll give a user unlimited skips if they sign up for a free account. It's owned by Amazon (AMZN). Spotify is another option for consumers, as is iHeart Radio, which is owned by traditional radio giant Clear Channel.
There are many additional competitors to Pandora, and I didn't even get into satellite radio, another real competitor. What exactly does Pandora offer that can't be replicated by competitors?
As I've outlined, Pandora's premium service has easily been replicated by Apple, and free options like Songza are comparable in most every way. Subscribers of Sirius XM (SIRI) can listen to unlimited online radio for an additional $3.50 per month, and that includes access to talk, news, and sports, genres Pandora doesn't currently offer.
Pandora bulls will point out that the company's service is increasingly being rolled out into vehicles and onto smart TVs. While having the option to listen to Pandora on the road is a positive for the company, vehicles also offer many other listening options, including satellite radio, the ability to easily plug in your smartphone, and the traditional choices, CDs and radio.
Pandora will never grow to the point where a majority of music listening users will embrace the service. And with a whole set of issues facing the service each time it tries to expand into a foreign market, major international expansion is unlikely.
I see significant downside for Pandora, based on increased competition, high content costs, and the company's lack of a competitive advantage. Pandora still has competition from traditional and satellite radio as well. I recommend current holders of the stock should lock in gains, and perhaps consider a short position as well.