Seeking Alpha
Growth, value, special situations, momentum
Profile| Send Message|
( followers)  

Last week, I wrote that Pandora (P) seemed to have stopped its slide and had perhaps found a level of support that would establish a trading range between $8.50 and $9.50. Instead, what we have is an equity that is drifting downward and is now on the cusp of breaking a new lower level and falling into the $7s.

It looks like I was wrong about the trading range that would be established, and now all we can do is watch and wait until this company does something to defend itself and its business model against a continued slide. What is amazing about this slide is that it is happening on lower-than-average bottom. What this tells me is that there are many simply sitting on the sidelines waiting for a concrete signal it is time to re-enter. Meanwhile, the downward trend will continue until something significant happens.

Ever since Pandora announced its latest results, the company has had challenges. Even with a growing listener base, better ad sales and subscription numbers, and more penetration into autos, Pandora has yet to prove the viability of its model. I often compare the Pandora story to that of Sirius XM (SIRI). The comparison is not so much as a service vs. a service, but rather an upstart trying to make its way and prove out a business model.

In the old days, Sirius XM had challenges of its own. I can remember long discussions about cash flow break even and when can satellite radio get there. I remember the company saying that it would happen at 2 million subscribers, then 3, then 4 -- and then not even bothering to put an estimate together anymore. These are the very types of discussions that Pandora needs to outline now. Long-time satellite radio investors should understand the dynamics faced by Pandora currently, and even if they hate to admit it, as stock traders, they could have a distinct advantage in playing the Pandora equity.

Pandora has gotten to a certain point in its business earlier than I would have anticipated. The point I am referring to is when there is a departure from betting on potential and a demand to understand when this company will turn the corner. In short, the Street is far less patient with the "potential" of Pandora and far more critical of seeing the metrics point toward profits.

The Netflix Impact

While Netflix (NFLX) may not be in exactly the same business as Pandora, the events of 2011 are fresh in the minds of anyone considering an investment in content distribution. Netflix was growing like gangbusters, but the costs of the content they distributed were such that the business model could not sustain. In a bold move, Netflix split its streaming and rental businesses and implemented a pricing structure that raised prices substantially, causing an exodus of subscribers as well as investors. The move caused the stock to tumble from highs of nearly $300 per share to lows near $60.

Currently, Netflix trades at about $106 and is in better shape to mold its business going forward despite continued challenges. The impacts of the Netflix moves were far-reaching. Even satellite radio provider Sirius XM was forced to abandon a proposed $3 price hike used to help it settle a class-action suit to a more modest $1.41 price increase. The indication is that there is not as much elasticity in Sirius XM's pricing as once thought.

I cannot help but think that Pandora is walking a fine line right now. The Street has lost patience and it seems that every move the company has made to bolster confidence has fallen short. Pandora is still months away from a new quarterly filing and the question on everyone's mind is what the company can do to stop a spiral downward.

While not a popular idea, I have been a proponent of Pandora instituting a royalty fee in much the same way Sirius XM does. The arguments against such a move is that Pandora enjoys so much listener growth because it is free. However, with survivability at stake, it may be just the move that Pandora needs to make. A modest fee of $1 per month could generate substantial revenue while essentially being transparent to users. Even if half of its 51 million active users were to walk away from the service, it would leave the company with 25.5 million users generating an additional $76.5 million per quarter. Put that $75 million into the balance sheet each quarter and the company quickly jumps into a profitable status. A bold move like this may be enough to stop the slide and return confidence to this equity. Of course, I am speaking in very general terms.

The Spotify Impact

Like it or not, Pandora needs to tip its hat to Spotify. Spotify has stormed onto the scene and offers something that Pandora and even Sirius XM can't: true on-demand streaming of music. If Spotify is seeing huge successes in gaining paying subscribers, it must be based on something "right" that they are doing. In my opinion, the success of Spotify is that it can offer up any song at any time. In essence, you are renting a massive music library. This is possible thanks to direct deals with the record labels. Pandora lacks such deals, as does Sirius XM. In fact, Sirius XM has filed a lawsuit alleging that Sound Exchange and others have impeded the company's ability to cut direct deals. The Sirius XM lawsuit could have potential ramifications for Pandora.

What Pandora and Sirius XM need to contend with is the fact that other services like Spotify and MOG can offer true on-demand music while they cannot. Sirius XM can fight with non-music content, but Pandora has no such offering. Spotify is shifting the dynamics of audio entertainment and will continue to do so with moves that grow its brand. The deal with Facebook has been wildly successful in building the Spotify brand. Pandora is teamed with Facebook as well, and Sirius XM has yet to cut such a deal.

Summary

In my opinion, Pandora is in a bit of trouble. It is in desperate need of something compelling that changes the fundamentals of its business model. The Street is being very demanding and Pandora needs to be able to satisfy these demands. Until there is something compelling, this equity is adrift -- and drifting in the wrong direction for longs. As you can see from my disclosure, I am not invested in Pandora. In fact, I have never owned a share. My strategy with this equity is to wait until the company proves itself. I have felt that has been a decent play for traders taking advantage of ranges, but as of now a new range has not been established. Until then, I would be on the sidelines waiting to see the bottom and confirmation of the bottom. Simply stated, Pandora is a wait-and-see equity.

Disclosure: I am long SIRI. I have no positions in P or NFLX.

Source: Pandora Continues Slide - When Will It Stop?