Pandora Media's (NYSE:P) results for the quarter ending in December were quite impressive, with both profits and revenue increasing. But the forecast for earnings per share for this year lies between $0.13 and $0.17, which is below analysts' expectations of $0.19 per share. The main reason behind this weak forecast for earnings is the aggressive investments that Pandora is making to keep up growth in users and to boost advertisement sales in the face of tough competition from Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG).
CEO Brian McAndrews quoted that, "Our bias will continue to be toward revenue growth and capturing additional market share." So Pandora could see some weak earnings figures since it is eyeing a greater share of the market. But is it a good buy at its 52-week high if we look at the various troubles that it is facing.
Increase in royalties will burden Pandora even more
Pandora pays record companies and publishers in lieu of the songs it plays. Last year, it paid 49% of its revenue to record companies, while 4% of its revenue went to publishers. Due to this large disparity in payments, publishers are struggling to earn money from digital music. Because of the royalty payments, Pandora has to pay for each song it plays, so it is unprofitable as of now. But for every song that Pandora plays, it gets money from ads.
Licensing organization ASCAP is likely to increase the current rate of royalties, according to Business Insider. It is mainly on account of publishers that ASCAP is increasing this rate, because, as mentioned already, the publishers are getting less pay as compared to singers and record companies. But this increase will put extra burden on Pandora's balance sheet to the extent that it can lead them to bankruptcy since the company had just $344 million in cash at the end of the last quarter, while it paid $339 million to publishers and record companies in 2013. An increase in royalties can further increase the payout to other parties and handicap Pandora.
Also, despite being one of the world's largest online music service companies, having 76 million active users, Pandora faces tough competition from Apple's new iTunes radio service and Google's music subscription service.
When compared to Google and Apple, Pandora lags in technology. Both Google and Apple have their own mobile hardware that enables them to incorporate their service directly into the mobile operating system. Also, if people turn to YouTube, Google has the advantage because of the wealth of data it has on its users.
Google is also pushing its All Access music service to next-generation devices such as the Google Glass. Recently, Google sent VIP invitations to subscribers of its music service to join the Glass Explorer program. Hence, if Google's Glass clicks in the future and becomes a hit with customers, then it might be difficult for Pandora to penetrate this market as well.
Apple is also pushing forth its iTunes radio service in an aggressive manner. It recently launched the service in Australia, making it the first non-U.S. country to get the platform. In the future, Apple aims to launch iTunes Radio in various markets such as the U.K., Canada, and New Zealand in early 2014. In the long run, Apple is aiming to take the service to more than 100 countries ultimately.
An overcrowded industry
To combat these rivals, Pandora is coming up with its own strategies. It is aiming to increase the value of its advertisements by increasing its ad load. In this regard, Pandora is introducing advertising for its in car service this year, and hopes to expand the market for this new service.
However Google and Apple also have plans to enter this service. With mobile and in-car service already taken into consideration, not much space is left for Pandora's expansion. It will have to venture into new areas like on demand streaming, which is currently dominated by YouTube. This will increase its advertising avenues without need of increasing the user base. Pandora will have to work hard to know the listening habits of its target audience.
There are other potent competitors as well in the form of Spotify, Rdio, Beats Music, and YouTube. This overcrowding of the music industry has caused Pandora to spend heavily on advertising and promotion to attract new customers, and this will ultimately hurt earnings.
The company is increasing its sales force to sell more slots to its advertisers to direct some ad budget to Pandora. Because of this extra selling and marketing costs, margin growth has been offset to some extent.
What should investors do?
Every investor wants to know whether the company could be profitable or not. And Pandora seems to have answered that question with the company expecting to show a profit for the full fiscal year in 2014, even though it had a weak start with losses in the first quarter. Yet, Pandora has to work more to impress investors. The company has covered a lot of ground in the U.S. but it might lose in the wake of competition from Google and Apple. The probable increase in royalties could be another headache, and could even drain its cash reserves and lead to bankruptcy.
So investors should sell Pandora since it is already trading at its 52-week high, and stay away from it till the time the company's strategies start giving results.
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.