Take Cover! Pandora Is a Web 2.0 Bubble Stock

Source: Thinkstock

Source: Thinkstock

A 1913 Act of Congress established the Federal Reserve Board with the contradictory dual mandate of managing the economy towards full employment and a stable price level. The Fed coordinates monetary policy as a blunt tool to influence interest rates and the aggregate economy. In a recession, the Federal Reserve favors low interest rates in order to encourage institutions and private individuals to take out loans, purchase stock, and commit to making capital investments. As the economy recovers, Federal Reserve officials generally target higher interest rates and tighter monetary policy in order to curtail inflation.

For now, Web 2.0 stocks such as Pandora (NYSE:P) appear to be riding a wave of speculative capital that traces its origins back to the Federal Reserve Board. Investors should consider dumping these shares before the clock strikes twelve and the bubble bursts. Former Fed Chair Alan Greenspan may define the Web 2.0 bubble as the second coming of “irrational exuberance.”

The Web 2.0 Economy

In Q4 2008, the Federal Reserve slashed its overnight lending rate to zero amid the housing crisis and credit bust. The Federal Reserve can influence the money supply by targeting particular interest rates upon overnight loans between member banks for reserves held at institution. From there, Federal Reserve and Treasury officials promptly added the terms Treasury Asset Relief Program (TARP), Term Asset-Backed Securities Loan Facility (TALF), and Money Market Investor Funding Facility (MMIFF) to the American financial lexicon. In all, the Federal Reserve balance sheet ballooned to $4.3 trillion by June 4, 2014.

In response to Federal Reserve crisis management, money market and bond rates have remained at the floor, while the Dow Jones Industrial Average continued to break record highs en route towards 17,000. Certainly, capital has been allocated towards the most speculative positions amid this bull market. Web 2.0 stocks, which would include Facebook (NASDAQ:FB), Twitter (NYSE:TWTR), Amazon (NASDAQ:AMZN), and Pandora are overvalued in comparison to underlying earnings power. Pandora stock closed out the June 9, 2014 trading session at $25.61 per share, which did calculate out to $5.1 billion in terms of market capitalization. Pandora has not turned an annual profit over the course of the past five years.

The Web 2.0 economy is eerily similar to that of the dot-com boom and bust. Each Web 2.0 website literally functions as a broker-dealer that matches consumers to online advertising. In fairness, today’s Web 2.0 ecosystem has added social and mobile components above the initial dot-com movement. Popular social media destinations cultivate an establish user base for the direct sales of goods. Traffic, however, does not always translate into revenue, and real growth at the bottom line. Pandora subscription radio and music streaming services face stiff entertainment competition out of traditional terrestrial radio, Spotify, Sirius XM Holdings (NASDAQ:SIRI), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), YouTube and, of course, Apple (NASDAQ:AAPL).

Last year, the Apple iTunes, Software, and services operating segment generated $16.1 billion in fiscal 2013 sales. On May 28, 2014, Apple announced that it would be purchasing Beats by Dre for $3 billion. Working together, Apple, Beats, and Jimmy Iovine are likely to break into new entertainment markets, at the expense of the Pandora business model.

The Bottom Line

A quick review of Pandora financial statements would highlight the fact that content acquisition costs consume the majority of revenue at the company. In prior years, Pandora investors faced the maddening prospects of content acquisition costs rising in tandem with the popularity of the service. For the latest quarter, Pandora rang up $140.6 million in revenue. Of this amount, $108.3 million went to pay for content acquisition costs, or royalties to musicians and record labels. Last year, content acquisition costs consumed 74.5 percent of quarterly revenue at Pandora.

For Q1 2014, Pandora revenue broke down to $140.6 million in advertising and $53.7 million in radio subscriptions. Be advised that Pandora advertising revenue may actually decline over the next 24 months, as the mobile market becomes increasingly saturated. A May 29, 2014 report out of International Data Corporation has foreshadowed “market challenges” in the tablet space through the end of 2014. This call did dovetail with relatively weak quarter-to-quarter sales for the Apple iPad.

Going forward, Microsoft (NASDAQ:MSFT) Surface Pro 3 tablet sales are also likely to disappoint. For Pandora, any slowdown in mobile advertising would hammer away at shares that have already been priced to perfection. Pandora investors should consider selling out of this stock, in order to avoid severe losses over the next eighteen months.

More From Wall St. Cheat Sheet: