Short Thoughts

As many of my readers know that I am short some stocks that I have written about on HypeZero:

With the market trending up the last couple of months, both Pandora and SHOS have skyrocketed costing me some money. However, Orchard has really tanked which has helped my short portfolio pretty much break even. Not bad in this market. 

I am keeping all three shorts as nothing fundamentally has changed from a business perspective at any of these three companies.

Because the market has gone up quite a bit, I am looking to add to my short portfolio. Here are some companies that have caught my eye as possible short candidates:

Zillow/Trulia

I have written that Zillow is better than Trulia based on sheer numbers. However, as I read more about this industry and these companies a couple of things concern me:

  • When I search for real estate in my area, I don’t use Zillow/Trulia because their information does not come from MLS so it is sometimes inaccurate or outdated. I use the realtor site run by Move Inc (MOVE).
  • I don’t see much of a difference between Move’s business plan and that of Zillow or Trulia. In fact, Move has better data.
  • Move has been around for a while and they have been struggling growing annual revenue past $200 million. Zillow is half the size at only $116 million in annual revenue, but worth 4+ times as much. As Zillow gets to Move’s size it will have similar growth problems.    
  • Sales and Marketing expenses are going up at a faster rate than revenue. If the market is so big and these companies have such a small percentage of the market size, why is it so hard to grow revenue? In 2012, Zillow revenue grew over 75+%, but sales and marketing grew over 100%. 2013 forecast calls for 45% revenue growth and 70% growth in sales and marketing expenses.
  • Both companies are trying to enter other markets by acquiring companies at premium prices. This is a big hint that the current business model does not justify the current valuation.
  • Zillow is barely profitable and Trulia is not profitable.

One thing that these companies have going for themselves is that the housing industry is bouncing back. This could result in real estate agents increasing their advertising spending on sites like Zillow. 

Moneygram (MGI)

I wrote that Wester Union is a value trap a couple of months back. Moneygram is Western Union’s biggest competitor, but it is smaller and does not enjoy Wester Union’s premium pricing. A couple of things concern me about this industry:

  • They charge the poorest people high prices to transfer small amount of money. Every year fees per transaction keep going down and there is constant pricing pressure. They need to increase the number of transactions per year just to keep revenue and profits from going down. Western Union, a huge cash cow, has been making $1 billion in profits for over 8 years.
  • Wester Union is performing price cuts across certain corridors and this should have an impact on Moneygram in 2013. 
  • New competitors (Xoom) and the wide adoption of smart phones will impact this industry in the future.

Monster/Dice

LinkedIn (LNKD) is hitting on all cylinders and the by-product of this that sites like Monster (MWW) and Dice (DHX) are hurting. Monster is at a 52 week low and I think Dice, a career website for technology professionals may be next. Even though the technology market is hot, Dice is barely growing revenue and profits. 

I will do more research on these companies before I short any of them.

Disclosure: I am short Pandora, Sears Hometown and Orchard Supply 

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. 

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.