In my first ever Seeking Alpha article, I discussed the prospects of Pandora (P) as a short idea, concluding that I simply do not like the risk/reward given the possibility of a takeover. Since, Pandora posted decent third quarter results, earning $0.06 per share (non-GAAP) on revenue of $182 million, both roughly in-line with analysts' estimates. The cash earnings were poor once again, though free cash flow moved closer to breakeven.
- Mobile ad revenue of $105 million (up 58% Y/Y)
- Total revenue of $180.4 (up 50% Y/Y)
- US Radio Market Share of 8.06% (6.61% last year)
The most striking and positive aspect of the third quarter was mobile ad revenue growing 58% Y/Y to $105 million. Companies across all spectrums want access to hyper-local mobile advertising, and I think Pandora is poised to capitalize on this demand. Local radio advertising has been around for a long time, so marketers are comfortable using the radio medium. Further, when Pandora users allow access to smartphone GPS systems, advertisers are able to provide incredibly relevant content that should command a premium and benefit the customer.
The only companies with comparable platforms that I can think of are Facebook (FB), Twitter (TWTR), Google (GOOG) and, of course, Apple's iTunes Radio (AAPL). I'm confident that greater competition will eventually surface, but for now, Pandora should enjoy a strong advantage.
Balance Sheet Strengthened
Investors tend to hate when companies dilute them by raising equity, but it makes a lot of sense for Pandora. Facing Apple and its absolutely massive cash pile, Pandora needed to add some cash to its coffers in order to provide flexibility in negotiations and improving its song catalog.
I like the move, but that does not change the fact that Pandora's million-song library cannot compete with Apple's 27 million songs. The hope is that users don't care as much about song discovery as they do about listening to the right songs. Nevertheless, a library war against Apple and Spotify won't create value for shareholders if we start seeing exclusivity bidding take hold.
- Free cash flow of negative $4 million YTD
- GAAP Loss of $0.01 per share in Q3
- GAAP Loss of $0.21 per share YTD
- Revenue guidance of $185 million to $190 million is below consensus
While I like the robust mobile advertising revenue growth, as a value investor, it is very hard to get excited about companies that cannot seem to make money. When you exclude some real costs of business (i.e. stock options), the company can post a positive EPS. Take away accounting gimmicks, and Pandora doesn't actually make money.
Of course, what I've learned from some of these tech companies is that earnings can escalate at a robust magnitude when management starts to manage profitability, so I wouldn't say that the results are necessarily reflective of Pandora's earnings power next year or five years down the road.
Overall, Pandora's Quarter was Decent
Unfortunately new CEO Brian McAndrews spent most of the conference call talking about his role in the company and answering some questions regarding the subscription mix and how it is impacted by lifting the hours cap. I would have liked to get a sense of his long-term vision for the company, but I suspect we will discover a lot more going forward.
Geotargted mobile advertising is a very attractive space to operate in, though, as I mentioned earlier, competition will continue to intensify as advertisers allocate more dollars away from traditional mediums to mobile.
I think it's too early to tell what the impact of iTunes Radio will be over the long-run, but it did not impact earnings as much as I thought it might.
Ultimately, I am not quite sure what will be the catalyst for Pandora to start generating meaningful free cash flow, and the fundamentals, while strong, are not compelling enough to justify a long position at the current valuation. Still, the threat of a buyout looms, so I remain on the sidelines in this situation.