I had a nice phone conversation with Steve Cakebread, Pandora's (P) CFO, on Thursday. After listening to Cakebread speak at several conferences, it's clear he's not the typical bean counter. I can always tell a good CFO from a bad one right away.
Cakebread belongs in the category of the good ones. People like Thomas Szkutak at Amazon.com (AMZN) and Peter Oppenheimer at Apple (AAPL). Search Seeking Alpha for the transcripts of Amazon and Apple conference calls. Like Szkutak and Oppenheimer, Cakebread appears to function as more than just a CFO. It seems to me that he takes an active role in the visioning process, both from the standpoints of coming up with ideas and seeing the ones that make the cut through. If not, he certainly talks a heck of a game for a bean counter.
There's never enough time to cover all of the topics I want to cover when I get somebody like Steve on the phone. Therefore, I will break this article down into sections, covering what I did ask. Based on the response to my articles and other yelps I've read about Pandora across the web, I determined what follows to matter most to investors.
I asked Cakebread to "separate fact from myth" with respect to the common critical contention that Pandora attempts to execute an unworkable business model because mobile listeners face data usage caps on smart phones. After a detailed discussion of the data landscape, he summed things up in one sentence: "The impact of data caps for Pandora listeners is almost non-existent."
Because we were on the phone and I am a slow note-taker, he sent along the following numbers based on analysis Pandora conducted regarding the data cap (non)issue:
Music streaming takes up much less bandwidth than people realize. For the techies: Pandora streams much more efficiently than you might have thought, in fact we use the most advanced music codec, AAC+, with a typical bitrate of 32 kilobits per second. At this rate, an hour of listening to Pandora on mobile consumes approximately 14 megabytes. Our average listener uses Pandora more than 10 hours per month, (18 hours as of the end of 2011) meaning that even if 100% of that listening were over mobile, it would consume around 140 megabytes per month, which is only 7% of the total usage allowed under a 2 gigabyte per month cap.
Because Cakebread is at least part bean counter, I asked if company founder Tim Westergren saying, in a recent USA Today interview, that Pandora is not really concerned with profitability right now made him "cringe." Certainly it's a sticking point with some investors.
Cakebread pointed out that Pandora has had profitable quarters and that it has been around breakeven for about two years and can continue to stay there. While he believes that, internally, the team needs to understand the importance of profitability, he warns against making too much money, too fast.
Cakebread told me that he can list "plenty of companies" that were wildly profitable early on, but are no longer with us. The endpoint - Pandora is in rapid growth mode. And fast-growing, pioneering companies that are disrupting industries risk sacrificing long-term profitability and sustainability by not investing enough in the business early on just to achieve profits. While you cannot spend recklessly, you have got to spend. In other words, by not spending today to grow in the name of profitability, Pandora could very well not position itself properly for the long haul. Cakebread claims that, ultimately, Pandora can sport a 20% margin.
The more tracks Pandora plays, the more it pays in royalty fees. Many bears point to that as reason number one why the company's streaming model cannot succeed. This is the only part of my talk with Cakebread where I wanted him to be more specific. To provide hard numbers to support his case.
That said, overall, I agree with his answer. In essence, paying for content is part of Pandora's business model. There's little, if anything, the company can do about that at this point. It feels that, over time, the number of listeners and hours listened will hit a certain level and sustain, slowing and, ultimately, stopping the growth of royalty payments. As Cakebread put it, they're not going to keep growing to 100% market share.
"They broke the ice." That's what Cakebread had to say when I asked him about Sirius XM (SIRI). By being the first to penetrate the dashboard, the satellite radio provider made it a place that could be home to more than buttons for AM/FM. Citing the company's different business models and approaches, Cakebread believes they can coexist.
He notes that, unlike Sirius XM, Pandora does not pay to get into an automaker's lineup. No dollars are exchanged in these deals. Cakebread credits Pandora's rapid adoption into automobiles, as well as a growing number of consumer electronic devices, to consumer demand for personalized radio. Automakers want Pandora because consumers tell them they want it in their vehicle.
On the general notion of competition, Cakebread was adamant that Pandora, Sirius XM, Spotify, Apple's iTunes and others can coexist without problems. He used the analogy of record stores living side-by-side with terrestrial radio. He likened the record store to a service like iTunes, noting that it's a complementary offering alongside Pandora. Cakebread then cited numbers that 80% of music listening happens in a "radio environment."
Some bears, particularly Brandon Matthews, made a big deal about insider selling at Pandora after the company's IPO lockup expired. Irresponsibly, they attempt to equate executive stock sales with a lack of confidence in a company's viability. Before I ever thought of talking to Cakebread, I took Matthews' argument apart on Robert Weinstein's trading site, Paid2Trade. You can read that entry here.
All people like Matthews have to do is pick up the phone. Cakebread was refreshingly open about his insider sales. The CFO agreed with how I characterized the selling in my question to him:
Rocco Pendola: It looks like you cashed in about $400,000 worth, leaving you with no shares, and Westergren brought in about $850,000, but still has more than 2.8 million shares left over (the State of California thanks you both). I don't blame any employee for selling IPO shares. Of course, IPOs are meant to help fund the business, but doesn't that include paying executives and other employees? Should investors be concerned that some sales took place and that you, correct me if I am wrong, do not own shares?
Paraphrasing most of Cakebread's answer, he noted that while he does not have direct shares left, he does have about 2 million options with about 1 million of them vested. He noted that no matter who you are, you need to manage your portfolio and keep it diversified. But, he considers his vested options the same way he would consider direct stock ownership. He has an incentive to execute and, in turn, move the stock price higher so that both he and the company's shareholders can reap the benefits.
While I am quite a bit more bullish on Pandora, I view them much in the same way I do Demand Media (DMD). Both companies have vocal critics who have taken very little time to study each company's business model and vision.
In both instances, having a background relevant to what they do helps. My radio and writing background have helped provide proper perspective in both cases. But you do not have to have worked in radio to understand Pandora (or in print and digital media to understand Demand). In fact, you can understand practically any company out there if you do your homework. While that includes conducting standard research (SEC filings, company history, competitive environment, etc.), it also means picking up the phone or sending an email. Generally, companies in what seem like us against the world positions are more willing to openly and candidly tell their stories than their detractors let on.
I walked away from my discussion with Cakebread confident in my current position in Pandora stock. I intend to escalate my purchases of the shares over the next six to 12 months.
Disclosure: I am long P.