Pandora: The Fall Is Coming

  • Pandora media has run up far ahead of its fundamentals.
  • The current valuations factor in high levels of earnings growth, something which the company has not reported since its inception.
  • The user metrics to stock price relationship is also hard to establish, let alone accept.
  • The stock is trading at speculative levels and investors would do well to stay away from this one.

Pandora media is overvalued

Pandora media (NYSE:P), a pioneer of internet radio has rallied over 100% in the last one year (Up to March 24th close). The rally has left investors (who cashed out) smiling their way to the banks. Let’s look at what could have fueled the price to life time highs and the recent drop attributed to news of iTunes entry into Android.

The rally could have been due to three reasons:

  • Significant improvement in financial performance,
  • Record growth in product acceptance, and
  • Probably a lot of speculation.

Pandora 2013 financial performance

The table below summarizes the company’s 2013 performance in comparison with the year ago performance.

All dollar values in 000's FY 2012 FY 2013 YoY Change
Revenue 410,009 637,893 55.6%
Gross profit 130,851 249,888 91.0%
Non-GAAP Net Income -6,542 11,546
Net Margin -1.6% 1.8% 3.4%

The company has had a great year in terms of revenue growth and earnings growth. However, the run up in price which has followed has been far ahead of the fundamental improvements. The stock has gained exponentially in relation to the fundamental performance.

The current valuation multiples of Pandora factor in a growth rate of close to 100% over the next five years, a fact which looks highly unlikely given that the firm is yet to report a GAAP Net profit since its inception. The forward P/E under various scenarios of earnings (Non-GAAP)  growth is shown in the table below.

2013 2014 2015 2016 2017 2018 2018 Forward P/E
Earnings (projected at 100% growth) 0.06 0.12 0.24 0.48 0.96 1.92 16.35
Earnings (projected at 80% growth) 0.06 0.11 0.19 0.35 0.63 1.13 27.69
Earnings (projected at 50% growth) 0.06 0.09 0.14 0.20 0.30 1.46 68.89

Current stock price is $31.39 (Mar 24, 2014 closing price)

Given the fact that Pandora media is yet to learn the word profitability, the relation between the fundamental performance and the stock price gains is hard to establish.

Product acceptance

The best measure of the acceptance of Pandora’s service should be the metrics reported by the company every month. Let’s look at the number of monthly active listeners and listening hours over the last one year.

Pandora media user metrics

The steady increase in listening hours has seen a drop in the last three months, something which will be a key focus in the face of increased competition from the likes of iTunes radio. The number of active listeners, earlier on a steady increase has also been more erratic, bringing into question the retention of customers and the churn rate among the company’s customers. Can the company continue to grow its active listeners? A critical question considering that the sector is seeing increasing competition from biggies like Google and Apple.

Let’s look at the yearly change in the user metrics, from Feb 2013-Feb 2014, displayed in the table below.

Feb 2013 Feb 2014 YoY change
Listening hours (billions) 1.38 1.51 9.4%
US market share 8.48% 8.91% 5.1%
Active listeners (millions) 67.7 75.3 11.2%

The changes in user metrics, though positive, do not justify the kind of stock price gains which we have seen over the last year. The fact that majority of Pandora’s success in growth of active listeners is on account of its first mover advantage, it will be interesting to see if the company can replicate this kind of success in other markets, where the first mover advantage will be missing.

A recent Seeking Alpha update stated Apple’s possible launch of an iTunes app for android. The implied conclusion: Apple gets access to customers who were until now exclusively available to Pandora media.

Pandora bull run fueled by trading/speculation

This is one possibility we cannot currently quantify. We therefore fall onto the method of rejecting the inappropriate. In this case the fundamentals-stock price and the user metrics-stock price relationships are hard to establish, let alone accept them. The only possibility left is the one constant of the equity market: The zeal of the traders/speculators, which we believe to be the main reason for Pandora stock gains.

Conclusion

Pandora’s stock is clearly cut-off from its fundamentals and even after the recent drop is still trading at speculative levels an investor would better avoid. The current stock is hard to justify even at 100% earnings growth over next 5 years, which seems almost impossible given the increased competition from the likes of Apple and Spotify.

To see Pandora’s latest stock price movement, click here (NYSE:P)

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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