Once again we see that investors can't draw a distinction between a great product and a good company.
I've been using Pandora for years. For my hours of listening pleasure, I have paid the firm exactly zero. I listen to what I want and don't pay. What a wonderful combination. But how does this translate into a company I want to own?
Clearly somebody gets it. Pandora (NYSE:P) seems to be the only stock going up in this afflicted market. Profitable companies that may actually pay dividends (horrors) are so passe. We want to speculate... er, invest... in companies that are sexy and cool and have GROWTH.
With the affinity shareholders firmly in control of Pandora, it now warrants a $2+ billion market value. Not surprisingly, the Pandora IPO was Topic #1 on CNBC all day yesterday.
Pandora Radio may be a free service, but CEO Joe Kennedy's comments are truly priceless. According to CNBC, he said:
We have a great track record of growing revenue.
We respect the need for operating margins.
We are putting no particular time frame on profitability.
We are putting no time frame on any financial metrics.
We have the ability to redefine radio.
Haven't we seen this all before? Oops, did I just betray my age?
Yes, I'm just old enough to remember the "new value metrics" like price per click, share of eyeballs, etc. And when there is no profit, just find the biggest number you can find and calculate a multiple from that.
At the offering price, the company [Pandora] had a market value of about $2.6 billion, or about 19 times last year’s sales, compared with about 2.7 times for Sirius XM Radio Inc. (NASDAQ:SIRI), the subscription-based satellite-radio service. Sirius XM had a market value of about $7.7 billion as of yesterday’s close.
Who knew that Sirius at $7 billion could be made to look cheap? But there it is ...
Nonetheless, at least one intrepid analyst (John Tinker at Maxim Group) thinks that Pandora is worth a Buy rating and a $23 price target. He first makes a market share argument -- "Pandora only has 3% of all radio listening – suggesting a lot of runway.” What else? Well, Tinker says the company is “revolutionizing the broadcast radio business.” Sound familiar?
Barrons.com goes through the whole argument ...Sales and users increasing at a torrid pace. Advertisers are salivating. Just you wait and see...
As for profit? This is my favorite part of the article -- Barron's says:
[T]he company will probably have $1.7 million in Ebitda this year, but a negative $2.1 million next year, as it ramps up R&D expenses and marketing spend. Gross margin is slipping, Tinker notes, as content costs go up. The company’s spend on music copyright licenses amounts to 50% of sales, he notes.
The problem is structural, as shown by Tinker’s comparison of Pandora to Netflix (NASDAQ:NFLX): “NFLX was basically profitable from day one through its physical distribution of DVDs. P is not yet profitable; the music business model has been disintermediated and fragmented by Apple (NASDAQ:AAPL) and has still not recovered, whereas the movie/TV business is harder to fragment.”
For that reason, Tinker values Pandora at what he calculates to be half of the market premium that Netflix enjoys, resulting in a forward multiple of 13 times enterprise value as a multiple of projected gross profit.
How did I know that Netflix (NFLX) would be mentioned?
Disinter-what? Is that a fancy term for what is happening to the economics of the radio/music business? Are they being destroyed? Does that mean that Pandora could REVOLUTIONIZE or REDEFINE the music and radio business, but never EVER turn a profit? The internet is after all a great deflationary device that crushes profit margins.
But ignore all that, don't miss out!
Don't question the valuation ...remember that "multiple to projected gross profit"! The beauty is that analysts can "project" any profit they want. With infinite revenue growth, gross margins will surely come. Out of respect for the CEO no doubt. Profits will probably follow? Let's not ruin a good thing!
Didn't we get in trouble with pro-forma numbers before? Sorry, that's just my age again.
Where are Henry Blodget and Mary Meeker when you need them?
Somehow the Pandora IPO could not be more appropriately (or ironically) timed. On a day when everything that has a gross margin above zero seems to be down, investors have found a cause and an escape.
But instead of buying P shares, I'm going to turn off CNBC and turn on Pandora...it's a LOT cheaper.
Disclosure: Short NFLX.