Pandora's Risks


So far, the young 2013 has been a banner year for Pandora Media (NYS: P) . The stock is up 20%, rising with the broad market and on news of solid growth in December, when its radio market share eclipsed 7% for the first time. It didn't hurt that the audio streamer has formed more than 1,000 partnerships including those with automakers. And while the stock holds plenty of promise as the best-known Internet radio option, it also faces plenty of challenges in an increasingly competitive space and with a business model that has yet to be profitable. In this excerpt from our premium research report, we take a look at some of the key risks facing the company as it tries to establish itself as the premier audio entertainer.

As a young company in an emerging industry, Pandora offers plenty of opportunities, but with those come a number of risks, especially since the company has yet to turn a profit. Management readily admits that its current business and future prospects are difficult to evaluate. Here are some of the major issues the company needs to deal with before it can become successful.

  • Competition: Radio is already a crowded field and it's becoming even more packed. Pandora fights for listeners with broadcast radio, satellite radio, and other streaming services like Spotify, Rhapsody, and ClearChannel's IHeartRadio, as well as free channels like Google's (NAS: GOOG) YouTube, but shockwaves recently rolled through the industry when Apple (NAS: AAPL) announced plans to offer its own audio streaming system. Shares of Pandora fell nearly 20% the day Apple made the initiative public. The iPhone maker is still in negotiations with content providers, and the impact of its streaming service is unclear, but the move underscores the fact that this field is only going to get more competitive. Rivals like Spotify and Sirius XM (NAS: SIRI) are also constantly innovating, expanding, and updating their content.

  • Slowing growth: Although shares of Pandora have fallen significantly since they debuted, this is still a growth play for investors. Revenue doubled from 2010 to 2011, and grew by 150% the year before that. More recently, though, the growth rate has begun trailing off. Twice since May, listener hours have declined sequentially, and in September only grew by 67% from a year ago, whereas listener hours more than doubled in February. With a P/S ratio near 4, Pandora will have to maintain a strong growth rate to justify its current stock price. Currently, analysts project a five-year compound annual growth rate of 39%. If that prediction holds true, Pandora's revenue will be more than five times greater by 2017. That will be a tough hurdle to clear without international penetration, changes in royalty rates, or major jumps in ad revenue or listener hours.

  • Content costs: Perhaps the biggest thorn in Pandora's side is the high content costs it must pay. Unlike most business models, including those of competitors like Sirius XM, the steep royalty rates mean the model isn't scalable. Even growing revenue has not made the company more profitable, as growth in content costs has actually outpaced sales in recent quarters. The inability to control those costs has been the key reason for Pandora's poor stock performance, and is the market's main criticism of the company. Legislation like the Internet Radio Fairness Act presents an opportunity to fix this, but Pandora cannot depend on the government alone. It needs to work on renegotiating royalty rates and making its advertising more valuable so that it can show investors some positive numbers on the bottom line.

If you found the analysis above to be helpful, I encourage to pick up the full report, which features a look at Pandora's opportunities, key areas to watch, and reasons to buy and sell. Best of all, it comes with a year's worth of free updates so you'll stay in the know as earning reports and other breaking news happens. To get started today, just click right here.

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Jeremy Bowman owns shares of Apple. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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