Wednesday, June 15, 2011

Love Pandora, Hate the Stock

Once again we see that investors can't draw a distinction between a great product and a good company.

I've been using Pandora for years.  For my hours of listening pleasure, I have paid the firm exactly zero. I listen to what I want and don't pay.  What a wonderful combination.  But how does this translate into a company I want to own?

Clearly somebody gets it. Pandora (P) seems to be the only stock going up in this afflicted market.  Profitable companies that may actually pay dividends (horrors) are so passe.  We want to speculate... er, invest... in companies that are sexy and cool and have GROWTH.

With the affinity shareholders firmly in control of Pandora, it now warrants a $2+ billion market value.  Not surprisingly, the Pandora IPO has been Topic #1 on CNBC all day.

Pandora Radio may be a free service, but CEO Joe Kennedy's comments are truly priceless.  According to CNBC, he said:

We have a great track record of growing revenue.
We respect the need for operating margins.
We are putting no particular time frame on profitability.
We are putting no time frame on any financial metrics.
 We have the ability to redefine radio.

Gotta love how each quote flows nicely into the next one.  Pandora does a great job of growing revenue.  When you start with revenue of zero and go up, the growth rates are impressive.  Wal-Mart (WMT) grew revenue quickly in the beginning also.  One store + one store = 100% revenue growth?

Well, Pandora has the added benefit of being able to run with operating margins at less than zero, if the above quote is to be believed.  Pandora has a "need for" positive operating margins?  Hey, it is a novel concept.  Sell a service for less than it costs to produce and they will come!   Hello revenue growth!  We'll make it up on volume.   

And we're talking about OPERATING margins... not profit margins.  Pandora, it seems, isn't even covering its cost of goods sold, let alone S,G&A.  Taxes?  Not to worry.  I smell REFUND.

No time table whatsoever on when (if ever) Pandora will actually turn a profit.  But no matter... kids these days think those are evil anyway.  Economic necessity?  Proof you are using resources wisely?  Nope.  Evidence of greed, corruption, coercion, and abuse.  We aren't takers... we're givers!   Wealth isn't created or destroyed.  Just spread around.  And Pandora is likely to redistribute plenty of wealth.

In the meantime, Pandora is a perfect New Age company.  A feel good company that doesn't feel the need to make money.

Haven't we seen this all before? Oops, did I just betray my age?

Yes, I'm just old enough to remember the "new value metrics" like price per click, share of eyeballs, etc.   And when there is no profit, just find the biggest number you can find and calculate a multiple from that.

Bloomberg was kind enough to point out that:
At the offering price, the company [Pandora] had a market value of about $2.6 billion, or about 19 times last year’s sales, compared with about 2.7 times for Sirius XM Radio Inc. (SIRI), the subscription-based satellite-radio service. Sirius XM had a market value of about $7.7 billion as of yesterday’s close.
Who knew that Sirius at $7 billion could be made to look cheap?  But there it is...

Nonetheless, at least one intrepid analyst (John Tinker at Maxim Group) thinks that Pandora is worth a Buy rating and a $23 price target.  He first makes a market share argument -- "Pandora only has 3% of all radio listening – suggesting a lot of runway.”  What else?  Well, Tinker says the company is “revolutionizing the broadcast radio business.”   Sound familiar? goes through the whole argument... Sales and users increasing at a torrid pace.  Advertisers are salivating.   Just you wait and see...

As for profit?  This is my favorite part of the article -- Barron's says:
 [T]he company will probably have $1.7 million in Ebitda this year, but a negative $2.1 million next year, as it ramps up R&D expenses and marketing spend. Gross margin is slipping, Tinker notes, as content costs go up. The company’s spend on music copyright licenses amounts to 50% of sales, he notes.
The problem is structural, as shown by Tinker’s comparison of Pandora to Netflix (NFLX): “NFLX was basically profitable from day one through its physical distribution of DVDs. P is not yet profitable; the music business model has been disintermediated and fragmented by Apple (AAPL) and has still not recovered, whereas the movie/TV business is harder to fragment.”
For that reason, Tinker values Pandora at what he calculates to be half of the market premium that Netflix enjoys, resulting in a forward multiple of 13 times enterprise value as a multiple of projected gross profit.
How did I know that Netflix (NFLX) would be mentioned?   

Disinter-what?  Is that a fancy term for what is happening to the economics of the radio/music business?  Are they being destroyed?  Does that mean that Pandora could REVOLUTIONIZE or REDEFINE the music and radio business, but never EVER turn a profit?  The internet is after all a great deflationary device that crushes profit margins.

But ignore all that, don't miss out!

Don't question the valuation... remember that "multiple to projected gross profit"!   The beauty is that analysts can "project" any profit they want.  With infinite revenue growth, gross margins will surely come.  Out of respect for the CEO no doubt.  Profits will probably follow?  Let's not ruin a good thing!  

Didn't we get in trouble with pro-forma numbers before?  Sorry, that's just my age again.

Where are Henry Blodget and  Mary Meeker when you need them? 

Somehow the Pandora IPO could not be more appropriately (or ironically) timed.  On a day when everything that has a gross margin above zero seems to be down, investors have found a cause and an escape.

But instead of buying P shares, I'm going to turn off CNBC and turn on's a LOT cheaper.

Disclosure: Short NFLX.


  1. very good article. Your writing style is fantastic !!

  2. I am not old enough to make sense of when it happened. But definitely remember the XM, sirius saga. Great ideas, revolutionize the space, and an investor's nightmare, free!! Free is the most expensive word.

  3. Off topic, have you look at RCL or CCL? Would love to hear your thoughts on or offline.