Please Don't Short the Music

Includes: NFLX, P, SIRI
by: John Gilliam

It's not a remix of Rihanna's multi-platinum "Please Don't Stop The Music," it's the implicit message you might just get from your broker in the form of a Reg T call this week if you are among the short sellers who have apparently targeted the music industry's established and evolving music delivery platforms. Such a trade seems to be just part of what became a larger secular trend that may be starting to get unwound - that of selling short content delivery platform companies like Netflix (Nasdaq: NFLX), SiriusXM (Nasdaq: SIRI) and others

After an early victory achieved by piling on as skittish Pandora (NYSE: P) investors raced for the exits in its first few days of trading, it appears that short sellers of Pandora have been getting squeezed in a big way this week. The stock has rallied from its lows, approaching $12, to trade as high as $21+ in Friday's session despite no substantive news or data that would seemingly justify such a large increase in Pandoras market cap. Interestingly, the company that many have suggested to be impacted the most by Pandora's success, SiriusXM (SIRI), has been rising over the last week or so as well. How can this be? Is this not a zero sum game? If Pandora's fortunes (and market cap) are improving, shouldn't Sirius be going the other way and vice versa?

Not necessarily. Without going into the very deep discussion of Sirius vs. Terrestrial radio vs. Pandora etc., we believe it is fair to say that there are a number of factors that may be causing more investors to buy into the Sirius story, not the least of which is the potential for SatRad 2.0 to drive revenue and subscriber increases as well as drive improvements in subscriber LTVs. Even Pandora's valuation itself could be a factor; if a company with Pandora's finances and prospects can drive a market cap north of $3 billion, perhaps Sirius might be worth a little more than previously thought? Regardless of where you end up in that debate, Sirius may not even need such a catalyst to get the shares moving, due to the nearly 300 million shares sold short, one of the largest total short positions on the NASDAQ. Though Sirius does have over 3 billion shares outstanding, and this makes the 300 million short shares a little less garish, it still has some significant long-term bullish implications when a company has 10% of its float sold short, because those shares represent future buy transactions when they are covered.

We believe short covering and also traders on the long side "piling on" in recognition of the increasing pressure on short sellers are among the most significant drivers of both Pandora and SiriusXM's recent gains. SiriusXM is by far the largest subscription music service in the US, and the short sellers have been hounding them for years. Pandora's highly publicized stock market debut was only a day or two old when the short sellers started to move aggressively into the mix. Now in each of these situations, it appears that the short sellers are getting a significant push back from the long side with Pandora rallying over 60% from last week's lows and SiriusXM also experiencing healthy gains on top of the full month's short interest data, evidencing the 20 million shares that have been "covered" since the data was last measured.

Another good example of short sellers targeting music delivery platform companies is what has transpired with Atrinsic, a small NASDAQ company that never had a short interest of much more than 10,000 shares in it's history until it acquired the iconic Kazaa streaming music service, making it the only publicly traded pure play in "on demand" (like Spotify) streaming music. Since that time, short sellers have gotten ever more aggressive, and as of the last count released Friday, they now have 412,000 shares sold short. Tiny (market cap $20m) ATRN/Kazaa only has 6 million shares outstanding and 82% are owned by insiders and related 5% owner hedge funds, leaving a public float of just 1.1 million shares (per the 10k/a filed last month).

As I started to write this note, I checked three (2 individuals, one hedge fund manager) investors' holdings; I know they are long-term investors with ATRN/Kazaa but below the 5% threshold. Each confirmed that their holdings had increased or held steady, that they were held for long-term investments and the total between the three was around 550,000 shares. This effectively reduces the 1.1 million shares available in the "public float" to around 550,000 shares.

Last week, former ATRN/Kazaa director Robert Ellin filed a 13D indicating that he had acquired another 145,000 shares since leaving the board. Has this effectively reduced the public float to 405,000 shares, a level that is actually below the Nasdaq reported short interest? The holdings we can confirm through SEC filings, and otherwise lead us to believe that could be the case, but the one thing that is 100% certain is that this is the largest short position as a percentage of the public float that we have ever seen. As the large short positions in the two other pure play music companies get unwound, and their prices are driven higher, will the traders driving the increase in shares of Pandora and Sirius begin to squeeze the ATRN / Kazaa short sellers too?

Regardless, with the enormous flow of capital into the streaming music space generally, the impending launch of Facebook's Music Dashboard (widely expected to be a watershed event for Spotify, Kazaa, MOG and the other "on demand" streaming music companies) and a broader buy in from investors in recognition of either a changing secular trend or short squeeze opportunity, we believe that short sellers targeting the music delivery companies might want to consider changing their tune.

Disclosure: Long SIRI, OTCPK:ATRN. Author has bid to acquire a stake in MOG through Second Market

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