Analyst: Here’s Why I’m Downgrading Pandora Media

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities. 

Downgrading Pandora Media (NYSE:P) shares to NEUTRAL from OUTPERFORM based upon valuation as shares have traded above our price target. While we have concerns about valuation, competition, and royalty  rates, we are raising our 12-month price target to $11.50 from $10 to reflect high expectations for Q4,  an improving advertising landscape for Pandora, and continued Internet and mobile growth. Our new price target reflects a multiple of 23x likely CY:15 EPS of $0.50.

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We do not see significant room for price appreciation due to a lack of nearterm profitability and continuing uncertainty about competition.  Pandora shares have traded up significantly in value since mid-November, despite lowered FY:13 guidance in December, with key headwinds remaining unresolved. Shares have likely benefitted from recent positive reports from Google (NASDAQ:GOOG) and Netflix (NASDAQ:NFLX).

We continue to expect Apple to announce a music streaming service in early 2013, although we have no details. Apple’s (NASDAQ:AAPL) leverage over the music labels through the success of iTunes could allow the company to introduce a service that includes many of the most popular features from Pandora and Spotify, a provider of on-demand music subscription services. We think Apple could take as much as 15% share from Pandora over time should it launch a similar service, although any prospective Apple service will see its growth limited by no Android support…

We also expect an update on the status of royalty rates early in the year. At an investor conference earlier this month, Pandora’s CEO stated that he expected the Internet and Radio Fairness Act to likely be introduced in some form in the new session of Congress. We do not expect any near-term benefit to Pandora from the legislative process, as negotiations are likely to be drawn out over many months. We believe that a final decision will keep the interests of performing artists first, and see a low probability that Pandora’s rates will be lowered meaningfully. With that said, we expect Pandora’s rates to remain stable for several years.

We remain optimistic about Q4. There may be slight upside to our estimates for revenue of $125 million and EPS of $(0.06), compared to guidance of $120 – 123 million and $(0.09) – (0.06), and consensus of $122 million and $(0.05). Listener hours through December tracked roughly in line with our expectations, and management was likely being overly conservative about the fiscal cliff impact.

Maintaining FY:13 estimates for revenue of $427 million and EPS of $(0.09).

Michael Pachter is an analyst at Wedbush Securities.

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