Name That Trade – $P: Pandora the Ex Roarer

by Dan August 12, 2014 3:12 pm • Commentary

In early May when rumors surfaced of Apple’s intention to buy Beats, we made a bullish play on Pandora with the stock was in the low $20s (read here) predicated on the fact that if digital music properties were to be in play, then:

Pandora is the obvious next derivative trade given their leadership position in the music streaming business. Despite being cut nearly in half since the all time highs in early March, the stock is still not particularly cheap, trading at a price to sales of about 5x. That being said, there are internet based companies with similar market caps like YELP that make Pandora look like WMT compared to AMZN. So, on a relative basis, if you thought there were catalysts or that there should be more of takeover premium for Pandora given the price tag for Beats, one could easily make the case why Amazon, Microsoft, Facebook, or Google to name a few could make a $6-7 billion bid or roughly a 50% premium for the company which would take it back up towards its prior highs.

We started to exit the position as the stock approached technical resistance at $30 six weeks later (here) and fully exited when it became apparent that the momentum off of the May lows had subsided (here) in early July.  I have kept a close eye on the stock, and took particular interest in the company’s Q2 results that showed a beat and raise on revenue and earnings was matched with a handful of disappointing metrics as it relates to advertising, particularly monetizing ads on their mobile app.  This obviously flies in the face of many of its internet “services” peers where most have show tremendous growth to mobile and ability to make money off of those users.

Make no mistake, Pandora has been a tremendous success story in digital streaming music, but in the eyes of Apple and possibly Google (who just bought music service Songza in early July) they may not be the way of the future. Pandora and private competitor Spotify have been routinely mentioned as take-over candidates, and to be fair there are no shortage of larger media and or internet companies who could have an interest but I suspect that Spotify is likely the first to go and thinking more and more that Pandora ends up being the sort of Napster of the last cycle who is left without a chair.

On a valuation basis, the stock is not particularly expensive (in terms of single digit multiple billion acquisitions terms) on a price to sales basis when you consider Zillow’s recent acquisition of Trulia for $3.5 billion in stock or about 10x 2014 sales, Pandora trades less than 6x this year.  Could MSFT, FB or GOOG digest this sort of property, yes, but the issue of paying billions for tens of millions of users who can be monetized through advertising is a fairly dicey proposition for an unproven medium like streaming music.

I am not a user of Pandora, and frankly know fewer and fewer people who are still. I have to suspect that Apple has a plan for Beats and the company is likely to make a power move for market share in the space.  So while my play in early May was to ride the M&A wave in an oversold stock, I have a decidedly different view at the moment given the recent weakness in some key metrics, rapidly changing landscape, and the stock’s inability to  hold a meaningful bounce as the Nasdaq made new 14 year highs last month.

From a technical perspective, the stock is hovering at key support, and looks to be about ready to exit the dreaded “Triangle of Death.” And not the good way:

Pandora 1yr chart from Bloomberg
Pandora 1yr chart from Bloomberg

On the next attempt and failure to break to the upside of the downtrend line I may be inclined to play for a move back to the support of the May low, just below $22.

Despite implied vol having a 5 handle on it in Pandora options, they are on the cheap side relative to its recent history, making vertical put spreads reasonably attractive:

Pandora 30 day at the money IV from Bloomberg
Pandora 30 day at the money IV from Bloomberg

I’m going to watch it for now but If I saw an entry a little higher than here that followed another failed move higher I’ll look for some reasonably priced put spreads.