Great Product Idea = Great Stock Idea?


Pandora Media's (NYS: P) coolness is in its genes. From the beginning, Pandora's Music Genome Project fit beautifully into today's uber-connected world, where individual tastes rule and passive consumption of media is becoming passe. Today, Pandora has more than 125 million registered users and 47 million active ones.

Pandora has cool cred and some passionate fans. But is it a cool stock idea? It has some major risks, but given the stock's fall from its IPO highs, it's looking like a good time to buy if you're not too averse to some real risks.

What's in Pandora's box?
Pandora's been narrowing its loss and is closer than ever to turning a profit. In the year ended January 2012, the company's revenue surged by 99.1% to $274.3 million, and it reported a loss of $16.1 million, or $0.19 per share.

That's quite an improvement from the year ended January 2009, when Pandora generated only $19.3 million in sales and reported a loss of $28.2 million, or $5.45 per share.

Analysts expect Pandora to steadily increase its revenue over the next several years, and that it will just turn a profit in the year ended January 2014. In other words, 2013 should be a very good year for Pandora, at least if all goes as expected.

Will it, though? Pandora competes with music services galore, and consumers have no shortage of ways to access tunes these days. Plus, there's only so much time in the day for listening to music (unless your full occupation is to Occupy Wall Street or something -- I'd imagine there's plenty of downtime).

Pandora competes with more established radio companies like Sirius XM, Clear Channel, and CBS, not to mention services provided by Apple's iTunes, Google (NAS: GOOG) , and Social-media musical service Spotify poses a major danger to Pandora, too; it also offers free listening pleasure and has major real estate in Facebook users' newsfeeds.

As is so often the case, some of these competitor companies may in some way be linked up; for example, Google actually acts as an "online advertising agency" for Pandora and represented 2.7% of the company's revenue last year.

Meanwhile, Pandora's licensing agreements require it to pay artists and their labels royalties for their content. These costs have hampered its profitability even though Pandora users only stream content, they don't buy it. It's a bit unfair, too, when you consider that Pandora's exposing listeners to new artists for free and creating new potential fans, not to mention paying concertgoers and merchandise purchasers.

Last year Pandora shelled out $150 million in royalties. Obviously, that takes a big bite out of all the sales it's managed to drum up through new advertising strategies in its streaming product, and in a case of the double-edged sword of success, the more listeners Pandora serves, the more royalty payouts it makes.

Pandora's negotiated royalty rates are due to increase a bit over the coming years, and it may have to use the courtroom in an attempt to renegotiate rate terms for the 2016-2020 period, which could add up to higher costs in the future.

Pandora: the price is right
Pandora shares are down nearly 40% since the company went public, marking a far better buying opportunity now. While far from a sure thing, this reduces the risk of buying in and ups the chance for stellar rewards.

Since it's not yet profitable, we can glance at Pandora's current price-to-sales ratio of just 5.90, compared with other as-yet-unprofitable recent IPOs with higher P/S ratios, such as Angie's List (NAS: ANGI) (P/S ratio: 7.72), Yelp (NAS: YELP) (P/S ratio: 13.01), and (oh my goodness!) Splunk (NAS: SPLK) (P/S ratio: 23.73).

When I decided to take a look at Pandora, I assumed I'd decide its shares were poison, given its lack of profitability and the competitive landscape. So much for assumptions. I'm thinking the price just may be right for a company that's nearing profitability and has been admirably increasing revenue and loyal fans and emphasizing the discovery of new music that's geared to fit individuals' tastes.

I'm putting Pandora on my watch list; there are some clear risks, no doubt, but its cool hunting core could help it keep on growing goodwill into the future. Would you buy Pandora now? Broadcast your thoughts in the comment box below.

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At the time thisarticle was published Alyce Lomaxowns no shares of any of the companies mentioned. The Motley Fool owns shares of, Apple, and Google.Motley Fool newsletter serviceshave recommended buying shares of, Google, and Apple and creating a bull call spread position in Apple. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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