Pandora’s Perfect Storm

With shares of Pandora Media (NYSE:P) trading at around $15.22, is P an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Pandora Media has made two highly strategic moves recently. It has allowed listeners to link to Pandora through their Facebook (NASDAQ:FB) accounts, and it has implemented a 40-hour limit of free listening per month. The former should increase exposure, and the latter should aid monetization. However, these moves still might not be enough to save Pandora.

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The stock has appreciated more than 65 percent year-to-date, but there are several red flags that investors seem to be ignoring. These red flags include a lack of profitability, fierce competition, and a subpar company culture.

Lack of Profitability

Pandora went public in 2011, but it launched in 2000. If a company is unable to deliver consistent profits after more than a decade, then there should be cause for concern. Of course, Pandora’s popularity increased after it went public, which led to more users and paid subscribers, but providing excuses for a company isn’t a wise investing strategy.

Management has been somewhat effective with increasing paid subscribers, and mobile ad revenue doubled last quarter. These are clear positives, but while revenue growth is always exciting, it doesn’t mean much if costs – content acquisition costs being the biggest factor in this case – prevent consistent profits.

Fierce Competition

As of right now, Spotify is the biggest competitor. Pandora is bigger, but Spotify is growing faster. This has a lot to do with the “cool factor” among the 18-35 demographic.

According to Alexa.com, Pandora is ranked #282 in the world and #54 in the United States. In other words, only 281 websites in the world receive more traffic than Pandora. Spotfiy is ranked #1085 in the world and #519 in the United States.

Over the past three months for Pandora, pageviews-per-user has increased 4.7 percent, time-on-site has increased 4.0 percent, and the bounce rate (only one pageview per visit) has declined 2.0 percent. These are all impressive numbers. Over the past three months for Spotify, pageviews-per-user has increased 1.1 percent, time-on-site has increased 8.0 percent, and the bounce rate has declined 2.0 percent. These are also impressive numbers.

In this instance, the numbers don’t reveal the whole truth. If you’re only looking at traffic numbers over the past three months, then it would seem as though it’s close to even. And if you’re including overall ranking, then Pandora looks like the dominating force. However, Spotify was launched in 2008. Therefore, despite eight fewer years of operation, it’s already a significant threat to Pandora.

As if Pandora didn’t already have enough to worry about on the competitive front, Google Inc. (NASDAQ:GOOG) and Apple Inc. (NASDAQ:AAPL) are also looking to jump into the game. This is similar to playing a game of one-on-one basketball against a neighborhood foe and winning by a point or two, and then the game changes when Michael Jordan and Kobe Bryant show up. Ambitions might be high, but reality is going to play a serious role.

Google Play Music All Access is up and running, and it’s supposedly coming to iOS within a matter of weeks. For $9.99 per month, subscribers have unlimited listening access to millions of songs, radio customization capability, a skipping feature, and more. For those who start the trial prior to June 30, the cost will only be $7.99 per month. Google also offers more content than Pandora and Spotify.

Pandora One offers no external ads and unlimited listening hours on all devices for only $3.99 per month (or $36 per year), and Spotify Unlimited offers unlimited music on desktops and laptops for $4.99 per month. Spotify also offers Spotify Premium, where listeners can enjoy ad-free music on any device for $9.99 per month. The latter option doesn’t seem so appealing with Google entering the fray.

And let’s not forget about Apple’s iRadio. Apple has reached an agreement with Warner Music Group, and it’s attempting to iron out a deal with Sony Music. There are many rumors that Apple is offering a much sweeter deal to Warner Music Group than Pandora. Apparently, this will come in the form of 10 percent of ad revenue opposed to the 4 percent of ad revenue Warner Music Group currently receives from Pandora.

Company Culture

According to Glassdoor.com, Pandora’s employees rate their employer a 3.4 of 5. This is decent, but if you read the actual employee reviews on Glassdoor, you will notice a few recurring themes, which include “no long-term game plan,” “needless spending,” “insecurity,” and “paranoia.” For comparative purposes, Spotify employees have rated their employer a 4.7 out of 5.

The chart below compares basic fundamentals for Pandora, Google, and Apple.

P GOOG AAPL
Trailing P/E N/A 25.96 10.76
Forward P/E 56.37 16.24 10.31
Profit Margin -9.86% 20.92% 23.46%
ROE -53.68% 16.36% 33.34%
Operating Cash Flow -2.28M 16.56B 55.26B
Dividend Yield N/A N/A 2.70%
Short Position 31.60% 1.80% 2.80%

Let’s take a look at some more important numbers prior to forming an opinion on this stock.

T = Technicals Are Mixed

Pandora has performed exceptionally well over the past year and year-to-date, but yesterday’s drop was a memorable one.

1 Month Year-To-Date 1 Year 3 Year
P 3.82% 65.80% 52.81% 0.00%
GOOG 2.59% 22.65% 51.95% 71.60%
AAPL 1.54% -13.64% -17.35% 76.21%

At $15.22, Pandora is still trading above its averages, but this might not last much longer.

50-Day SMA 15.06
200-Day SMA 12.14
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E = Equity to Debt Ratio Is Strong

The debt-to-equity ratio for Pandora is much stronger than the industry average of 4.20.

Debt-To-Equity Cash Long-Term Debt
P 0.00 75.42M 0.00
GOOG 0.10 50.10B 7.38B
AAPL 0.00 39.14B 0.00

E = Earnings Are Weak

While revenue has been impressive, any company that consistently loses money is a risky investment.

Fiscal Year 2009 2010 2011 2012 2013
Revenue ($) in millions 19 55 138 274 427
Diluted EPS ($) NA NA -1.03 -0.19 -0.23

Looking at the last quarter on a year-over-year basis, revenue improved but the loss widened.

Quarter Apr. 30, 2012 Jul. 31, 2012 Oct. 31, 2012 Jan. 31, 2013 Apr. 30, 2013
Revenue ($) in millions 80.78 101.27 120 125.09 125.51
Diluted EPS ($) -0.12 -0.03 0.01 -0.09 -0.16

Now let’s take a look at the next page for the Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

Conclusion

Pandora has paved the way for the industry. Therefore, in a perfect world, it should be rewarded. Unfortunately, this is far from a perfect world. Pandora is a company that cannot turn consistent profits, and with competition increasing, it’s highly unlikely that this will change. A few profitable quarters are possible, but it would be difficult to see Pandora fighting off all threats over the long haul. Even if competition isn’t factored into the equation, margins are poor, cash flow is weak, and nobody knows how the stock would perform in a bear market.

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Pandora might be enjoying phenomenal stock momentum year-to-date, but based on the changing industry landscape, it looks like an extremely risky investment. Pandora is a STAY AWAY.

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All content posted should not be considered professional advice. Please do your own research and consult with a professional financial advisor before making any investment decisions. I don’t have any positions in this stock.