Shorting Pandora

Pandora LogoPandora (P) is an internet radio service. “The company allows listeners to create up to 100 personalized stations to access unlimited hours of free music and comedy, as well as offers a paid subscription service to listeners.” Most of their revenue comes from advertisements that are run between songs. 

Yesterday, the company announced quarterly results that beat market expectations, but provided lowered fourth quarter guidance. The company blamed soft guidance on advertisers being cautious with spending due to macroeconomic concerns such as the fiscal cliff.

Due to weak guidance, the stock is down around 18% to $7.80 today. 

I have wanted to short Pandora for a long time, but never got around to doing it. But, finally I initiated a small short position today at $7.79. Here are the reasons for the short: 

Profitability

Even with huge subscriber growth, Pandora is having a hard time just breaking even. The reason is that Pandora has to pay royalties for every song a user listens to. So, as advertising revenue increases as more users join Pandora, so does the “content acquisition” cost.

In fact, it gets worse. The royalty rates are going to increase every year under the “Pureplay Settlement” with SoundExchange, which has set predetermined prices every year until 2015. 

Pandora has been lobbying in Washington to lower these rates to boost profitability. However, I don’t think anything will materialize and even if something does, it will be a long time away.

Competition

There is plenty of competition in this space. The biggest ones are Spotify, Apple, and Amazon. Spotify has a very similar service to Pandora except

  • Spotify has integration with Facebook which allows users to share songs with friends.
  • Spotify is free on personal computers. You can listen to any song in their library for free.

There has been a rumbling that Apple may enter the interent radio space. It seems a natural fit for Apple and Amazon as they already provide music content.

Also, there is nothing holding users from using other services beside maybe personalized stations that have been created on Pandora.

Conclusion

I am confident that Pandora will continue to go lower. The only thing that could save it is if it negotiates better rates for content acquisition.

Disclosure: I am short Pandora.

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