Check Your Scales: Pandora Is A Net Exporter Of Content

Apr.13.12 | About: Pandora Media (P)

Pandora (P) is a leading competitor in streaming music, with a relatively unambitious market cap of $1.48 billion. But regardless of affordability and leadership, bears raise sustainability concerns regarding its supply costs in licensing content. And it is true that Pandora, as a pioneer in negotiating with the record labels, does currently overpay. But Pandora is not at a secular supply cost disadvantage, and I'd like to offer two points to clarify this.

Pandora has no inherently weakening, long-term characteristic to undermine it in onward content negotiations (relative to other streaming music companies). If there's a problem now, it's artifactual, as dinosaurs in the music industry are very slowly realizing they need to work with, not against, the Internet. But there's an even bigger reason to say Pandora investors shouldn't worry about content supply.

The Reason Stephen Faulkner Should Immediately Cover His Short Position

Pandora doesn't just import content. Pandora fabricates content, more so than any other streaming music provider. In fact, Pandora is ultimately a net exporter of content because it creates a uniquely defined experience. Just listen to the reason Faulkner is shorting Pandora:

I want on-demand, not "give me a playlist I may or may not like" when I am in a position to provide my own input.

In other words, it's not just about listening to music. It's about listening to music the way you want to. And Pandora delivers in this dimension. Over a long period of time, it gathers a profile of your tastes in music to the point that, no matter what mood you're in, Pandora can pick songs for you better than you can pick songs for yourself. At this point, Pandora is no longer an importer of content -- it is more of an exporter.

So Faulkner is right to say content and presentation come first, but wrong to be shorting Pandora on this basis. I think he's confused about Pandora's value proposition because understanding it requires a textured visualization of scale. Consider what leading theoretical physicist Lisa Randall writes in her book:

Lack of scale separation can have disastrous consequences.

Sometimes an object of study's characteristics do not translate across scales. Faulkner observes a characteristic of Pandora at one scale, the scale of articulating a new stream of specialized radio, and projects it across all scales -- i.e., experiencing a fully developed stream. Faulkner also assumes all streaming content distributors, from Pandora to Facebook to SiriusXM (SIRI), are ultimately competing across the same wavelength. That's a mistake. Randall:

When scientists have turned out to be wrong in the past, it was often because they hadn't yet explored very tiny or very large distances or extremely high energies or speeds.

Pandora stretches out the time scale for a person identifying their tastes -- that's the user input. At the same time, in terms of output, the Genome Project condenses the frequency of the listening experience into a stream of only your favorite styles in a given category. In this fusion of long-term preference observation and short-term preference delivery, Pandora is breaking a "strong bond" of conventional experience and forming a fundamentally new substance and/or releasing a new stream of energy.

In other words, Pandora improves the listening experience, does so with proprietary data collected from millions of people, and by these criteria is clearly a net exporter of content. So bears are going to have to be a little more creative. "Music costs money" is not a sufficient argument.

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Source: Google Finance.

Pandora Isn't Netflix

I have compared Pandora to Netflix (NFLX) in the past and said they were both equally moat-less beyond brand, but there is a problem with this claim of similarity. It is true that Netflix and Pandora both have proprietary data from user preferences. But Pandora's data are in songs, which last minutes, and Netflix's are in movies, which last hours. Netflix's data are therefore more "simple" and easily replaced.

So, Pandora has more data than Netflix, and this should comprise much more of a moat. Again, we see that scale must be considered before drawing conclusions across categories. Faulkner should be more considerate. In particular, Faulkner and friends should look at the micro-scale of what Pandora delivers, and realize that Pandora is exporting content in a class of its own.

Disclosure: I am long P.