Pandora Assessment After the Spike: It’s the Netflix of Music – and That’s Good and Bad

For a while there, Internet radio company Pandora Media (P) looked like just another social twee that had sadly overestimating its own value. Like a whole lot of other wildly popular products, making enough money to pay for it was proving difficult. But some excitement was pumped into the stock in late August, as seen in this stock chart.

P data by YCharts

Shares of Pandora shot up following an earnings announcement that included a 53% revenue gain, a hint of profitability, a 48% rise in listeners and an 80% rise in the number of hours they listen. Since those last two factoids are particularly helpful when pitching ads to businesses, investors see real profits on the horizon. Two analysts upgraded their hold ratings to buys. One of them, Canaccord analyst Michael Graham, has a $16 price target on the shares. (Pandora’s respected CFO also announced his resignation, for mundane reasons, but investors apparently didn’t hold it against the company.)

As an innovative enterprise, Pandora is going great guns. The company streams customized song lists, through PCs and mobile devices, to listeners that either pay for the service or subject themselves to ads. By the end of July, it had some 55 million active listeners and a more than 6% share of the U.S. radio listener market, making it a huge threat to traditional radio. The product seems to be spreading well and moving toward profits on those all-important phones and tablets, overcoming a problem that has flummoxed Facebook (FB). It’s also expanding internationally.

P Revenue TTM data by YCharts

As an investment, there are still some questions. The price/sales ratio on the shares is about 5.7. While that’s not a shocking level for a growth company, it indicates big expectations for a $2 billion market cap company. Bulls on the stock are working off assumptions of a 55% gain in revenues this year and profits (of the EPS variety) the following year.

While valuing great growth is always tricky, it’s made more so here because of Pandora’s evolving competition. A Nielsen survey last month showed that most 13-to-17 year olds prefer finding new music (and listening to music generally) on Google’s (GOOG) YouTube, which is free and typically commercial-free. Pandora, which picks songs for listeners based on their past preferences, fell in behind radio, Apple’s (AAPL) iTunes and CDs. Pandora’s doing great at grabbing the traditional radio market, but so are competitors Spotify, Amazon (AMZN) Music and those favored Apple and Google products. All of these places pay royalties for the same music Pandora streams, and their decisions about how much they will pay have a great effect on Pandora’s costs. Some of them, like Apple and Google, can afford to pay up for music and throw money toward attracting listeners without much worry.

P Cash and ST Investments data by YCharts

Pandora’s investors take the competition seriously. A Wall Street Journal article Sept. 7 that said Apple was building a Pandora competitor caused Pandora shares to lose a lot of those recent gains on earnings and upgrades. The article, citing unnamed people familiar with the matter, said Apple was in talks to license music for the new service.

In other words, getting to the great growth in Pandora’s share price requires great revenue gains, steady profit improvement and unsurprising costs -- goals that powerful competitors could make difficult to achieve. Pandora’s an important player doing well in a big, fast-evolving industry that many want to control. For investors, the bet is that it can one-up whatever the best of those competitors can dish out.

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

Filed under: Company Analysis