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Shares in Pandora (NYSE:P) continue to add to this year's momentum as investors applaud the continued progress in its monetization efforts of its existing user base.

Valuing such a business depends on "sustainable" revenues and earnings a few year's ahead in time, something impossible to predict for now. I remain on the sidelines.

Third Quarter Results

Pandora generated third quarter revenues of $180.4 million, up 50.3% on the year before. Analysts were looking for revenues of $178.3 million.

A net profit of $2.1 million last year was turned into a net loss of $1.7 million, with GAAP losses coming in at a penny per share.

On a non-GAAP basis, Pandora reported earnings of $0.06 per share, in line with consensus estimates.

Looking Into The Third Quarter

Strong revenue growth continues to be driven by subscription services revenues which rose by 162.1% to $36.0 million. Advertising revenues were up by 35.8% to $144.3 million.

Content acquisition costs remain the biggest expense for Pandora. At nearly $87 million they make up 48.2% of total revenues, down 6.5 percent point compared to last year.

Yet the bottom line did not see much improvement as major cost categories such as sales and marketing expenses as well as selling, general and administrative expenses doubled in actual dollar amounts.

... And Further Ahead

Revenues for the final quarter of the year are seen between $185 and $190 million. Non-GAAP earnings are seen between $0.02 and $0.04 per share.

Analysts were looking for revenues of $186 million on non-GAAP earnings of $0.04 per share.

The company announced that it will align the fiscal year of the firm with the calendar year going forward.


Pandora ended the quarter with $447.8 million in cash, equivalents and short term investments. The firm operates without the assumption of debt, for a solid net cash position.

Revenues for the first nine months of this year came in at $463.2 million, up 53.4% on the year before. Net losses narrowed from $38.1 million to $23.6 million. At this pace annual revenues are seen around $660 million, as non-GAAP earnings are seen between three and five cents.

Trading around $29 per share, the market values Pandora at $5.6 billion. This values operating assets at $5.1 billion, the equivalent of 7.7 times annual revenues.

Give the lack of earnings, Pandora does not pay a dividend at the moment.

Some Historical Perspective

Shares of Pandora have traded in a $10-$20 trading range following its public offering in the summer of 2011. Shares fell to lows of $7 by the end of last year but have quadrupled ever since to highs of $32 in recent weeks.

From reporting literally no revenues about four yeas ago, Pandora is now on track to generate revenues of $660 million for this year. The company posted modest net losses in recent years.

Investment Thesis

Pandora, just like its many competitors, is going after a huge market, radio listening. Like most products and services, the internet and smartphones are creating huge changes in how consumer use this service in their cars, at home or at work.

The key benefit is that Pandora and competing services allow a free and a personalized product. With this approach, Pandora now has 70.9 million active users, about 7.5% of the US radio listening market. Its users spend nearly 4.2 billion hours per quarter listening to the music, of which mobile accounts for about 80% of listening hours.

Unlike traditional radio, Pandora is still suffering from huge costs, notably content acquisition costs. These costs have fallen to little below 50% of revenues, which compares to a long-term target of 40% of revenues. Combined with operating leverage, this should result in operating margins of about 20% in the future.

For now these margins are not attainable as Pandora is boosting expenditures and investments to grow its user base and operations. This can easily be achieved following a secondary offering in September of this year, raising enough cash to move forward for quite some time.

After shares have more than tripled this year, it might be time to get cautious a bit. The active listener base fell by 1.8 million to 70.9 million listeners after facing more competition. Apple's (OTC:APPL) iTunes offering captured a reportedly 11 million listeners in days, while Spotify remains a worthy competitor as well.

Back in August, I last took a look at Pandora's prospects. A disappointing quarterly report with a lack of short term profits sent shares towards $18 per share. Ever since shares have seen a huge run-up of nearly 75% in just three months time, adding to this year's momentum.

The good thing is that additional investments are resulting in strong growth in advertising revenues per listening hour, putting relative content-acquisition costs under pressure, thereby demonstrating the long-term validity of Pandora's business model. The fact that mobile revenues surpassed the $100 million mark is comforting as well given the huge reliance on mobile users.

After abandoning the listening cap of 40 hours, many would expect that subscription revenues would come under pressure. It seems that they held up quite nicely over the past quarter. With 71 million subscribers being valued at over $70 per user each, the valuation has risen a lot, especially given the low switching costs to other radio platforms.

I have to conclude the valuation remains tricky and some imagination is needed to properly value this business addressing a huge market opportunity.

For now I remain very cautious given this year's momentum, but I could foresee revenues of $2 billion by 2016/2017, allowing Pandora to report some meaningful profits. Attaching the right valuation multiple to that is tricky, especially given competitive developments and uncertain business model developments.

For now I remain on the sidelines. I might reconsider my stance after a more prolonged correction, or after witnessing continued improvements in gross margins and a leveling off of marketing expenses.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.