Pandora By The Numbers

Internet Radio Fairness Act

In my last article, I gave a general idea of why I initiated a small short position in Pandora (P). I argued the only way the stock has a chance of going up is if there is new legislation that significantly lowers music royalty rates.

This legislation is the “Internet Radio Fairness Act”, or IRFA. In fact, Pandora CEO is currently arguing on Capitol Hill that the royalty fees that it pays as a percentage of revenue (50+%) are unfair compared to what satellite radio (8%) and radio stations (0%) pay. Pandora wants Washington to cut royalty rates by more than 80%. On the other side, musicians are arguing that they do not make much as is.

I don’t understand why Washington has to get involved and if a company (Pandora) cannot make money based on the current royalty structure why is it still in business. Comparing royalty rates as a percentage of revenue is meaningless. For example, if Pandora gets higher advertising revenue, then the royalty rates a percentage of revenue go down. Maybe it needs to play more advertisements. Maybe it needs a new business model.

I don’t expect that the bill will get passed in its current state. However, if it does, the following table lists trailing 4 quarter earnings if there is a drastic 85% cut in royalty rates (35% tax rate).

  Jan 2012 April 2012 July 2012 October 2012
Earnings $21 Million $18 Million $29 Million $37 Million
Earnings Per Share .13/share .11/share .18/share .22/share

By my rough calculations, Pandora would have trailing 12 months earnings of .64/share or over $100 million and its stock price would more than double. On the other hand, it would also bring new competition into the now more profitable industry.  

Growth

There is no doubt that Pandora has experienced tremendous growth to the number of users and more importantly to listener hours. The growth is mostly due to the growth in smart phones. Users tend to listen more on phones, then on computers. 

However, this growth will slow considerably. Pandora had 62.4 million active users in the month of November. That is about 20% of the total US population. Also, the smart phone market is pretty mature in the US. See figure below. 

US Smart Phone MarketSource: Business Insider 

Monthly listener hours (in billions) numbers prove growth is slowing significantly. 

  Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Listener Hours .975 1 1..06 1.1 1.08 1.12 1.16 1.15 1.25 1.27
Growth(Y/Y) 101% 88% 87% 87% 77% 76% 70% 67% 65% 58%

One thing to note is that listening on the phone per hour is less profitable than on computers for Pandora due to lower advertisement revenues.

Conclusion

I only have a small short position in Pandora because of the current legislation risk. But I feel there are many things working against Pandora and expect that eventually the price of the stock will go down. Another way that I am thinking of playing Pandora is selling December naked calls as they are priced pretty high due to the stock’s volatility. 

Disclosure: I am short Pandora. 

2 thoughts on “Pandora By The Numbers

  1. You are right be short this one. I mean what kind of business is this. Think about this. I bought Nokia WP and i have similar Nokia music service and dont need to use pandora. In addition, i have xbox music that i can play any music i want (there is ad interruptions in every 7 or 8 songs, or pay premium $10 with no interruptions). The problem is Pandora is a radio that might or might not play the songs i want at the time. With XBM i can play any music. This business is terible let alone their $1.4 billion market cap. And of course you have speculation that apple will offer similar service which would be devastating for P.

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