Pandora Destined For Failure: Great Idea But A Poor Business

Sep. 6.11 | About: Pandora Media (P)
  • Since our inception in 2000, we have incurred significant net operating losses and as of October 31, 2010, we had an accumulated deficit of $83.9 million. A key element of our strategy is to aggressively increase the number of listeners and listener hours to increase our market penetration. However, as our number of listener hours increases, the royalties we pay for content acquisition also increase. We have not in the past generated, and may not in the future generate, sufficient revenue from the sale of advertising and subscriptions to offset such royalty expenses. If we cannot successfully earn revenue at a rate that exceeds the operational costs associated with increased listener hours, we may not be able to achieve or sustain profitability. In addition, we expect to invest heavily in our operations to support anticipated future growth and public company reporting and compliance obligations. As a result of these factors, we expect to continue to incur operating losses on an annual basis through at least the end of fiscal 2012.
  • Our operation [is] under an evolving music industry licensing structure that may change or cease to exist, which in turn may result in a significant increase in our operating expenses.

In 1998, at the height of the bubble, almost every IPO sported statement such as the one posted above in its prospectus. Fast forward 13 years later and investors are still ignoring the risks associated with failing business models; this time it’s with Pandora (P) who many still consider the “death knell” to Sirius XM (SIRI).

In an article written last week, I told you how I perceived Pandora to always be Sirius’s apprentice. To make my point, I mentioned how the recent success of Sirius XM, allowed many investors to take risks they ordinarily would not take in a company such as Pandora; one that has loss money since its inception. To make matters worse, its management continues to dismiss any questions regarding its ability at ever earning a profit. Warren Buffett once said “price is what you pay, value is what you get.” But if one is a Pandora shareholder, according to its management, you will be paying only the price for the foreseeable future.

But I can’t help but realize that Pandora is a great idea, but it’s just a bad business. Or as Buffett would put it, “it’s a business with poor economics.” The question that I have is, is this 1998 all over again? This was when the dot.coms came out of the woodwork and filed hideous IPOs that had literally no business of ever becoming successful. So how can anyone still claim that Pandora, with all of its fundamental flaws is any legitimate threat to Sirius? I can argue that Pandora is a more highly speculative equity than Sirius at this juncture.

The fact of the matter is a great percentage of Pandora's CAPEX are committed towards marketing as well as content acquisitions; which are also known as royalties. All of these expenses continue to eat away at its revenues. What makes matters worse is that Pandora’s business has placed it in a “lose-lose situation.” First, the company does indeed want to grow, but what many investors fail to realize is that as its user base grows, so does the costs it is required to pay in terms of royalties.

This is what management knows and fears will ultimately cause the company’s demise. This is the same management team that has yet to figure out a way to generate a profit after 10 years of operation. So let me ask Pandora investors, where is the value in your shares? It is clear that the only Pandora will ever become profitable is under new management, under a new business model but the more likely outcome is by being acquired.

For this reason, let all of the “Pandora is a threat to Sirius” cease and decease today. And I would ask that all of the Pandora investors “run for the exits while you still can.”

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Speaking of running for the exits, it seems that is exactly what the Pandora faithful have been doing over the past three months since the company’s hype-filled IPO. Is it possible that they have seen the light or better yet, have opened “Pandora’s box” and were not pleased with what they saw? Who can be pleased with sequential quarterly losses and a management team who refuses to answer questions directly; a lot of which has to do with its poor outlook.

Management now expects total sales for the full year to arrive in the range of $270 million and $275 million. This would place the year-over-year growth of approximately 96 percent. But what is not surprising is that it expects to lose between 5 cents and 7 cents per share in earnings; which does not include stock-based compensation expense. Also if you recall, there were a couple of bullets in its S1 filing states the following:

  • We intend to use a portion of the net proceeds of this offering to pay accrued and unpaid dividends on our redeemable convertible preferred stock in connection with the automatic conversion of such redeemable convertible preferred stock into common stock upon the closing of this offering. The amount of such accrued dividends will be equal to (1) approximately $29.7 million.
  • As a result of these factors, we expect to continue to incur operating losses on an annual basis through at least the end of fiscal 2012.

I gave the company credit for having earned 95 million in its most recent earnings report, but it was forced to pay 25% of that to unpaid royalties as outlined in the S1. Also in the prospectus, the company prided itself on having 90 million users in the U.S. and a collection of 800,000 songs. It sold many investors on its ability of monetize its user and songs as it relates to advertising revenue, but it failed to disclose that such aggressive advertising growth projections are not as feasible on mobile devices. Not to mention that Pandora unless it is acquired or fundamentally change its model, competition from the likes of Sirius, Apple (AAPL) and “dare I say” terrestrial will continue to pose significant threats.

On the subject of Acquisitions, one of the possible saviors of Pandora would be to be acquired by a company such as Research In Motion (RIMM). This would present many synergistic advantages to both companies. But the primary reason would be for RIM’s own interest in the music space which it recently launched and titled BBM Music Service. Not to mention what Pandora might do for what might become an exclusive Blackberry only application.


As of Friday’s close, Pandora sports a market cap of 1.9 billion. With a management team that will only discuss a possible profit after the arrival of 2013, the obvious question is why are investors buying this stock? Investors are better off waiting for the company to prove that it can operate and make some money; particularly in a market where there is a multitude of music options.

Investors often make the mistake and fail to distinguish between a company’s popularity with its ability to operate a successful business. Pandora reminds me a lot of Napster; a great idea, but a poor business in the end.

Disclosure: I am long SIRI, RIMM.