Pandora Media: A High-Risk, High-Reward Growth Play

Attempting to discuss the appropriate valuation for Internet radio giant Pandora Media is a tough game, at best. For investors interested in the company, the typical metrics simply aren't useful. Luckily, though, there are a few numbers and stories that investors should watch (beyond sales and earnings) -- ones that shed some light on Pandora's prospects and whether it is an attractive growth stock.

There is no denying that Pandora holds a large stake in the quickly transforming music industry. While investors didn't love the recent earnings report, here are the more important factors to focus on.

Though Pandora is not a new business, it is firmly positioned at the very beginning of a massive trend. The company serves as a music curator -- an important distinction from services such as Spotify and Apple's iTunes Radio. While the former capitalizes on another monumental shift in the music industry (on-demand streaming), the latter, direct competing service has not meaningfully affected Pandora's business.

Investors need to remember that this is a music discovery engine, which is an increasingly crucial element for music businesses. With more and more content available than ever before, finding the good stuff is becoming a monumental task. The companies behind the musicians need Pandora and its dedicated millions of active listeners.

Putting aside the recent 70% sales increase and 94% jump in subscription revenue, just look at the sheer scale of Pandora's influence over today's radio landscape:

  • 4.8 billion listener hours in the first fiscal quarter.
  • 75.3 million active listeners as of the end of March.
  • 9.1% of the total U.S. radio market.

This service reaches a tremendous amount of its market, and is only going to grow that presence over the next few years and beyond.

Will it ever go?
The company's profitability is limited, and occasionally nonexistent. This is the cost of pushing an industry-leading service in a still nascent and volatile business environment. A fellow Fool recently noted Pandora's skyrocketing sales and marketing expense -- up more than 60% in the just-ended quarter. As Pandora is by far the leading Internet radio business, and during a time in which Apple is trying to break its own entrant in the space, the added push to keep Pandora's name at the top is a necessary and likely short-term surge.

What's more important for investors is the increasingly heated debate regarding royalties. Recently, Pandora scored a victory on the publishing end of the business (regarding payments to songwriters and copyright owners, as opposed to recorded music royalties) as the New York District Court ruled in favor of keeping Pandora's royalty payout to songwriter rights and collections organization ASCAP at 1.85% of the company's total revenue. ASCAP had wanted the number to go to 3% over time -- similar to what iTunes Radio currently pays. For comparison, the amount that Pandora pays to record labels (the recorded music royalty) hovers around 50% of the company's revenue.

These are the most crucial stories to watch with the company. As Pandora continues to scale up, its ability to charge more for and attract greater advertising will climb in line. The company seems to have kept a lid on the potential content-cost explosion, at least for the time being. As long as the trend continues, investors need to look further out beyond this year's expected earnings per share. This isn't a value lover's stock, and it's not supposed to be. It's a complex business in a disruptive space, and the normal metrics simply do not apply. For high-growth, risk-taking investors, though, take a close look at the underlying potential in Pandora.

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The article Pandora Media: A High-Risk, High-Reward Growth Play originally appeared on

Michael Lewis has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple and Pandora Media. 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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