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It seems that lately Pandora (P) investors are grasping at straws trying to find a bit of hope or a little wish and a prayer that something magical might happen to drive the price of Pandora stock at least back up to IPO levels, or perhaps further. Again and again, the comments seem to be "If Pandora can do X, then the share price should do Y" or "If this company over here were to buy Pandora, the share price would go through the roof!"

But is this a reason to invest in a company? It's wonderful to sit there and say, "OK, I own this stock, and if some magic happens, it will go up," but is that a sound basis for investment? Not really. Investing in hopes and wishes and dreams typically results in disappointment down the line. The majority of those who have invested in Pandora since its IPO are just that, disappointed, considering the stock is currently floating around the $9 level after dropping roughly 10% in the past week.

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Investors not only need to consider the "possible" but also the "probable." Two scenarios that keep coming up that need to be addressed are the following:

  1. Pandora's battle over royalty rates.
  2. Pandora as a possible acquisition target.

Pandora's battle over royalty rates comes first. The argument from Pandora here is outlined simply in an email plea sent out by the founder of Pandora, Tim Westergren, regarding proposed legislation (H.R. 6480: Internet Radio Fairness Act of 2012). In the email, Westergren pleads with users to voice support of the bill because:

This bipartisan bill will correct the incredible inequity in how different digital radio formats are treated under the law when it comes to setting royalties. The difference is quite extraordinary. In 2011,Pandora paid over 50% of our revenues in performance royalties, while Sirius XM Radio (SIRI) paid less than 10%.

Not only does Westergren's plea not paint the full picture as I outlined here, it reeks of desperation. As Pandora currently struggles to turn a profit, this appears to be a last ditch effort to save what could very well be a sinking ship.

The solution, Tim, is quite simple. It's not a matter of crying to congress asking for a law to protect how much you have to pay for the music you give away to listeners for free. It's a matter of increasing advertisements delivered to your listeners on a per song basis, or charging a subscription fee so that you can pay the requested royalty rates and concurrently turn a profit. Investors need to ask themselves why Pandora is petitioning congress for a law which will tell rights holders how much they are allowed to charge for their work, rather than simply ramping up the delivered ads or creating a subscription based service.

That's where the focus should be. Investors need to stop hoping for a congressional miracle, and start asking Westergren for answers. Is it fair to artists to have their music delivered by Pandora free of charge to listeners, and to have Pandora tell the artists they are not going to pay them what they request for their work? Instead of writing congress, asking them to force artists to sell their work for lower rates, people should be writing Tim Westergren, asking why he can't make Pandora into a viable business without the government stepping in and giving Pandora a handout.

Seeking Alpha author Michael Slattery recently posted an article dealing with these two topics here. In it Michael states:

If this law passes and Pandora's primary cost to do business is reduced from 50% to 10%, the company's earnings and certainly earnings momentum will take an unprecedented jump. As counterintuitive as the next statement may sound, their stock may not, primarily because it might not exist on the NASDAQ exchange any longer.

Pandora may be a better component to a currently profitable media conglomerate's stable of holdings than as a stand-alone, independent Internet radio streaming service. Many articles have followed this train of thought while detailing each individual company's specific rationale. A Google search of "Pandora as an acquisition target" will provide you with a month of reading material. Clear Channel Communications (CCMO.OB), Amazon (AMZN) and Google (GOOG), have all been proposed candidate in several articles including two from Business Week and Forbes. Clear Channel, a media corporation that is a major holder of radio stations as well as a force in advertising, could well be interested because of the demographic shift to mobile use with advertisers following. David Guarino has recently written a compelling Seeking Alpha article on the likelihood and rationale for any number of companies swallowing whole, this tasty morsel.

It's the perfect segue into the second issue I would like to cover, and that is the idea that Pandora is some sort of attractive acquisition target that just very well may be scooped up by any number of companies waiting to pounce. It's another hope, dream, prayer, or whatever you want to call it. Investing in Pandora, or holding an investment in any company for that matter, on the hopes that another company will come in and make an offer is extremely speculative at best.

Besides, what company would wish to purchase Pandora if it can't turn a consistent profit without congressional intervention? Is it possible another company with deep pockets will come in and buy Pandora at these levels? Maybe. Is it probable? Absolutely not. Pandora may find itself bought out for its user base if the share price takes another nose dive, but it's unlikely that that buy out would come in at $9 or more per share. Investing in the hopes and dreams of a buyout will often get you nowhere, and I think in the case of Pandora, it's a death sentence for your money. With no "moat" to speak of, or barrier to entry, Pandora is defenseless. Another company would be better off making its own competing service than to pay top dollar for Pandora over what is, in my opinion, a current pricey $9.49 per share.

The writing is on the wall here. Pandora is crying to congress for help because they can't turn a profit by giving away content to users for free with limited exposure to advertising, and because they can't get enough paying subscribers from their extensive base of "free" listeners. If I were an investor, I'd sell immediately just like the insiders have been doing en masse, or at the very least I would demand some real answers from Tim Westergren on why he can't make this business model "work." Pandora is a nice little service for some free music, but it's a terrible business and one which investors should stay away from.

Source: Crying To Congress Will Not Save Pandora's Investors