Regular readers know that I don’t place too strong an emphasis on sell side analyst research ratings changes. I generally don’t unless that analyst making the move has a proven track record on the industry, the company’s products and has a knack for timing industry and single stock inflection points. There are few internet analysts on the Street who check all of those boxes, and one in particular, who I have gotten to know through our joint appearances on CNBC, SunTrust’s Bob Peck.
This morning Peck upgraded shares of Pandora to a Buy, and raised the target. Here are the highlights from his note:
The most important take-aways from the note are his feelings that Street estimates are conservative and that there’s m&a potential. Add to the mix the nearly 25% short interest in the stock and the risk/reward feels a bit asymmetric with the stock trading 2.36x expected 2016 sales. To put their expected 2016 sales of $1.4 billion in some context (on 78 million active user base, assuming 9 to 10 million paid), Tim Cook last week announced that their streaming music service, Apple Music likely has 17 million subscribers. Assuming that the average is $11.50 a month (single sub $9.99-month, $99 annual, family is $14.99/month), that amounts to close to $2.5 billion for annual subscription revenues.
Spotify, who is the leader in subscription streaming, with 30 million paid, and 70 million ad supported are the 800 pound gorilla in terms of scale, so if Pandora is able to reduce churn and actually gain share on Spotify they could become a fairly valued property target by bigger media companies.
With a savvy activist involved, pushing for a sale, I suspect Peck takes some solace in the fact that even if his fundamental reasons don’t materialize near term, there should be some support near the levels Corvex made their case for the company in mid May near $10 (despite being 40% from current levels):
Both Pandora and Amazon Music will be launching expanded/new streaming products in the next few weeks, with $5 price points taking aim at Spotify and Apple. Pandora will be first out of the gate, according to the New York Times:
Pandora is expected to make the first move by unveiling, perhaps as early as this week, an expanded version of its $5 subscription platform. That service, which is currently limited to removing ads on its internet radio streams, will soon begin offering customers new features like the ability to skip more unwanted songs and store several hours’ worth of playlists online, according to three people with direct knowledge of the company’s plans.
By Christmas, according to these people, Pandora wants to introduce a fully developed competitor to Spotify and Apple Music, with a catalog of tens of millions of songs that a listener can gain access to on demand. That version is expected to cost $10 a month, in line with the current market.
If this story interests you, one would need to have conviction that a takeout is possible, and that between now and then the company is able to lessen churn, lower royalty payments to labels and grow subscription products. Remembering that Pandora management has turned down a $15 bid from Liberty Media, $14 seems like a decent entry, except for the uncertainty around near term fundamentals. Oh, and the company IPO’d with a sale of 15 million shares at $16 in June 2011, and then sold 21 million in Sept 2013 in a secondary sale at $25, I suspect any take-out is somewhere in the middle of that range, call it $20.
If I were inclined to play for a takeout near $20 in the next six months, but am apprehensive of a long entry 100% from the 52 week lows made in February, despite the stock only being up 6% on the year, I would consider the following trade structure to better define risk:
Pandora (P – $14.25) Sell the Mar17 11 put to buy the Mar17 16 / 20 call spread for 10 cents
- Sell to open 1 Mar 11 put at 85 cents
- Buy to open 1 March 16 call for 1.40
- Sell to open 1 March 20 call at 45 cents
Break-Even on March expiration:
Profits: up to 3.90 between 16.10 and 20 with max gain above 20
Losses: of 10 cents between 11 and 16, put 100 shares of stock at 11 or lower and suffer losses (down 22%)
Rationale: This trade gives plenty of room to the downside on March expiration (only real losses occur below $11 where you would be put the stock). It allows participation above 16 up to a realistic level of $20 in the stock. The most likely scenario is a loss of 10c if the stock is between 11 and 16, but risking just 10c to be long P below 11 or above 16 is the best way to look at this trade. And anything in between is just noise.