Pandora: Go With Your Gut

P

Summary

  • New CEO could be a turnaround point towards profitability.
  • Tailoring to user preferences is still unique in a saturated market.
  • Spotify IPO may provide a useful valuation benchmark.
  • P stock is borderline speculation at this current time.

To start off, I am a strong believer in following your gut. That said, you have to do your research and due diligence in order to come to a conclusion where your 'gut feeling' means anything. After hours and hours of research, you begin to form a feeling about a company and sometimes this can be the best 'metric' to follow.

Pandora (P), I believe, is one such stock. The online radio has been around since 2000 and has been a forerunner in the industry for a majority of the time. Until recently, there have been limited competitors and the Pandora user base and listening hours have been increasing. However, now there is Spotify, Apple Music (AAPL), Amazon Music (AMZN), Google Play Music (GOOG), and iHeartRadio, among others. This increased competition naturally requires an increase in innovation in order to remain ahead and a need to cater to the growing generation of millennials.

Management

This brings us to our first point, CEO Roger Lynch. Lynch is the former CEO of Dish's Sling TV, an "over-the-top" internet subscription television service, and also worked as a banker on the IPO of Broadcast.com back in the late '90s. Lynch is joining Pandora at a difficult and challenging time. This year, former CEO Tim Westergren left, Ticketfly was sold off, and SiriusXM (SIRI) invested $480 million into the media company. As seen in the chart below, halfway through 2017 Pandora's cash and equivalents position skyrocketed.

P Cash and Equivalents (Quarterly) data by YCharts

Pandora needed cash. As of June 30, 2017 Pandora owed $209.7 million just in guaranteed commitments by the end of the year along with continuing to fund its expansion into the on-demand service.

The expansion into on-demand drained Pandora's cash pile. Cash flow for 2014, 2015, and 2016 was a net loss of ($30,406), ($169,661), and ($342,978) respectively (dollars in mil). The investment by SiriusXM and sale of Ticketfly allow Pandora more time to prove results from its new initiative.

Technology/Competition

The online music streaming competition is fierce, with players such as Apple Music, Google Play Music, and Spotify, Pandora is not alone and needs to be innovative to survive.

Company Inception Countries Users Subscribers

Apple Music

June 2015 115 30 mil 30 mil
Google Play Music + YouTube Red November 2011 + November 2014 63 + 4 ~7 mil ~7 mil
Spotify October 2008 60 140 mil 60 mil
Pandora January 2000 3 81 mil 5.05 mil

*Table completed by author using data from P, GOOG, and AAPL 10-K. Also Spotify

Despite all this competition, online music streaming is still not an extremely profitable business, at least with current business models. With a majority of providers revenue being used for royalties, margins are tight for much needed innovation. For example, Spotify had revenues of $3.3 billion in 2016, a 52% rise from 2015. Despite this, the company finished the year with a total loss of $601.4 million, up 133% from 2015.

Pandora had revenues of $1.4 billion for 2016 with a loss of $342.9 million. A reason for this was that content acquisition costs increased $124 million:

"...primarily due to an increase in content acquisition costs subject to the license agreements for recorded music with major and independent labels, distributors, PROs and publishers that were signed in 2015 and 2016."

However, Pandora's biggest competitive advantage is its extensive database of user preferences/tastes and its ability to adapt to switching preferences through its radio technology, "Music Genome Project". This personalization is what keeps users coming back to Pandora. Just recently, CEO Lynch allowed Pandora listeners on-demand service in exchange for watching an advertisement. This is a move meant to grab the attention of the younger generation who tend towards choosing their songs rather than random selection.

Release the Kraken

With a Spotify IPO coming closer and closer, online music streamers are in for a fight. As of 2016 Spotify owned half the industry revenue ($7.6 billion) with $3.3 billion. The rest is split between ~5 major players and a plethora of small guys.

Spotify is currently valued at ~$20 billion compared to Pandora at $1.17 billion.

P Market Cap data by YCharts

Spotify will be a worthy competitor with the company averaging ~1.7 million subscribers per month, and an end of year estimation of 68.6 million subscribers. The company is also projected to see impressive growth in 2018 with estimates showing end of year subscribers could come close to, or even pass, 100 million.

However, a Spotify IPO will be good thing for investors just for the sake of comparison. Now there will be a pure music streaming company which will allow for easier valuations of companies such as Pandora.

Speculation?

As mentioned earlier, Pandora's entry into the on-demand service opens many doors and should increase subscriptions and revenue. The opportunity for users to have on-demand selection along with the added bonus of a radio that learns and adapts to your preferences is incredible. This added subscription tier should provide a much needed boost towards Pandora's top-line and finally allow Pandora to become profitable in the coming years.

However, the looming problem of royalties still remains. Major producers, Publishers and artists still have a tight grip on the industry and will keep margins tight until something new comes along and upsets the industry.

P Revenue (Annual) data by YCharts

Despite this, Pandora seems well positioned with a new CEO and expansion into on-demand service to stay competitive and begin its journey towards profitability. It is also worth to point out that from my previous chart, you can see that Pandora is making roughly 1/3 the revenue as Spotify off of 1/12 the subscribers, putting Pandora in an excellent position if growth continues.

This is where the 'gut-feeling' comes into play. Investing into a company that has never been profitable, in an industry that struggles to be profitable as whole, in a growing tech world where piracy will always remain a major threat, Pandora may be a smart play especially after the stock has been beaten down into low single digits.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.