MorningWord 11/26/14: How Long Can You Hold Your $P?

by Dan November 26, 2014 9:44 am • Commentary

Pandora has been a controversial stock in 2014.  After gaining more than 50% by early March, making new all time highs, the stock has since fallen about 55% and is within 10% of the recent 52 week lows. Interestingly enough, with the stock down in the dumps, Wall Street Analysts have not abandoned their bullish thesis on the streaming music pioneer.  They have 24 Buy, 6 Hold and only 3 Sell ratings, with an average 12 month price target of about $30, or some 50% higher than current levels.

Yesterday saw a little push and pull from the analyst community though.  FBR Capital Markets downgraded Pandora to a Hold, suggesting the potential for a much higher cost structure given the trajectory of music licensing costs and what is sure to be increased competition from the likes of Amazon Prime, Google Play, and Apple’s impending relaunch of iTunes and Beats in the new year. Per

“We see the service as providing a quality consumer experience with solid revenue potential, but (we also) see a meaningful risk of debilitating cost structures emerging from the Copyright Royalty Board’s process of setting 2016-2020 performance fees,” wrote FBR Capital Markets analyst Barton Crockett in a report on Tuesday.

“We believe … there is a reasonable likelihood that rates get set substantially above Pandora’s expectations, which would cause a significant decline in its equity value, prompting us to see the current stock price as overvalued,” Crockett said. FBR Capital Markets more than halved Pandora’s price target, to 11 from 28, and pared the Web music-streaming company’s rating to underperform from market perform.

Yesterday afternoon, RBC Capital Markets internet analyst (one who I think is tops on the Street), Mark Mahaney, reiterated his bullish stance on the stock, citing some positive results in a proprietary survey of 1,300 U.S. internet users.  While Mahaney recognizes the potential for higher costs in 2015, he remains positive on valuation.  Per Mahaney’s research note:

Attractive Valuation – P’s current ’15 multiples of 3.4x P/S & 28x EV/EBITDA are close to trough 3-year levels. We believe slowing Metrics and the uncertain CRB process are the main drivers of these trough trends. Against close to 30% Revenue and 70% EBITDA 3-year forward CAGRs, we view current valuation as attractive.

Reiterate Outperform Rating and $35PT – Pandora is continuing on its path to sustained profitability, with meaningful Content Cost Leverage despite slowing user Metrics. We continue to see P executing well despite a consistently crowded competitive set. The building out of the local ad salesforce and continued integration into mainstream radio ad-buying platforms will all combine to improve Mobile monetization. We also view P as having significant strategic value and as a clear derivative on the media retail to media-rental shift and the connected-car

I have also had two separate mindsets in 2014, bullish when the stock had declined from $40 to $22.50, suggesting on May 9th that the stock was oversold and had strategic value (here):

Pandora, like most high valuation/high growth stocks has had a big move from its highs, and further movement down is likely dependent on the broad market at these levels.  If the broad market plays catch up to the downside, I would expect the round-tripping to take place, but if large caps continue to hold, smaller cap more speculative names will likely put in a short term bottom soon. Playing for a bounce from here and any potential rumors of it becoming an acquisition target should only be done through defined risk structures

I bought a September Call Spread, and closed it for gains when the stock was $29 in late June.

But as the summer wore on, and it became clear that the competitive landscape was rapidly moving below Pandora’s feet, I took a less sanguine view towards the company’s and the stock’s prospects, from August 14th (here and here):

It is my fundamental view that Pandora is fighting a battle they won’t win and that the weakness displayed in Q2 in RPMs (revenue per thousand hours) and the miss of consensus estimates for active users will only be exasperated when Apple relaunches iTunes/iRadio with Beats which I suspect will be in first half of 2015. Timing will be tricky, and the stock will be prone to short squeezes like yesterday


I have no idea whether Pandora is a legitimate takeout candidate, and I suspect rumors will continue to swirl, but without the takeover premium, Pandora is likely facing increasing competitive headwinds at a time where fundamentals may not justify current valuation.

I closed that bearish position in October for a very healthy gain when the stock was a bit above current levels, down 20% in two months from the trade initiation (here).

So where am I now on the stock and the prospects for the company?  Well, for those holding out for an acquisition, I think it is important to remember that for years, investors thought that digital media pioneers from the Web 1.5 cycle, RealNetworks and Napster, were surely going to be taken over by those looking to leapfrog their competitors.  It never heappend, Napster was taken under by Best Buy and I think since shut down, and RealNet, who knows.

It seems that Apple has made its bed with Beats, but obviously AMZN, FB, GOOGL, MSFT and YHOO, not to mention a media company, could clearly be interested. SO, the mere rumor of a takeout could see the stock back in the mid $20s (ICYMI the CEO bought nearly $500,000 worth of stock a few weeks back.) But I see little reason to play for the big one in either direction with lottery ticket strategies because options prices in Pandora are back near 52 week lows (despite the price of the stock very near 52 week lows) making closer to the money/higher probability directional plays attractive with defined risk:

Pandora 1yr chart of 30 day at the money IV from Bloomberg
Pandora 1yr chart of 30 day at the money IV from Bloomberg

Implied vol is suprising low for a stock that seems to be very controversial, the set up looks interesting with the stock nearing severely ovserold technical levels with what appears to be increasingly negative sentiment as to the company’s competetive positioning.