Pandora's Potential Makes It a Buy

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Despite my bearishness toward terrestrial radio, I have a soft spot in my heart for the business. I literally grew up in and on the radio. I wish the people running the business were not so inept. It pains me to watch the industry continue to fade into irrelevancy. For nostalgic reasons and because of my continued interest in all things radio, I receive a daily email blast from Radio-Info.com.

The summary transcends terrestrial radio and provides valuable information and insights on everything from the modern version of AM radio, Sirius XM ( SIRI), to burgeoning Internet radio. It also publishes data that shows how much money radio stations across the country bring in in sales each year.

Earlier in the week, Radio-Info published the top 10 highest billing radio stations in the nation. Not surprisingly, most of them operate in the nation's largest markets, particularly New York City, Los Angeles, Chicago and Washington, D.C. While that list helped me illustrate Pandora's ( P) opportunity in local advertising sales, Radio-Info's rundown of the top 10 billers in Chicago provides even more color. Before we consider the meaning of the Chicago numbers vis-à-vis Pandora, let's do some important stage-setting.

To understand, Pandora's opportunity in local radio advertising, it helps to understand its opportunity in the mobile ad space. I detailed the potential in an article earlier in the week:
I estimate that Pandora's sales efforts accounted for about 6.9% of all mobile ad revenue in 2011. If the company secured just 7% of all mobile ad revenue in 2016, it would generate mobile ad revenue of $758.1 million, based on eMarketer's forecast.

That presents the very real possibility of more than $1 billion in sales.

And, of course, that 7% number is incredibly conservative, given Pandora's current growth rate and investments into the sales end of the business.

Also earlier this week, the New York Times ran a story that not only touted Pandora's enormous opportunity in local radio ad sales, but the progress it is making stealing clients away from traditional broadcast radio:
Pandora's pitch to advertisers is that its technology can cater to consumers with far greater precision than radio - it can pinpoint listeners by age and sex, ZIP code or even musical taste - and that as it grows, Pandora will effectively be the top station in many cities...

This year, Pandora has had 400 local advertising campaigns across the country. One new client was Planet Honda in Union, N.J., whose president, William Feinstein, said he gave up on terrestrial radio years ago because he felt it cast too wide and expensive a demographic net.

But attracted by Pandora's ZIP-code targeting, he spent $10,000 to advertise on the service in January. IPhone traffic to his Web site - which he attributes to the ads - more than quadrupled, Mr. Feinstein said, and so he increased his spending to $15,000, then $20,000.

"A light bulb went off," he said at Pandora's party, holding a glass of wine. "We don't need to buy five radio stations. We can buy one."

Pandora already generates impressive ratings in markets across the nation, particularly the big ones. For obvious reasons this matters to ad buyers. Expect this dynamic to come into its own as Pandora ramps up its sales team and somebody, somewhere finally comes up with a standard procedure to measure Internet radio listening.

As an aside, ratings provider Arbitron ( ARB), which counts on radio broadcaster Clear Channel ( CCMO.PK) for 24% of its total revenue, seems to have little incentive to step into the future and work with Pandora and other Internet radio pioneers. At some point, a company will develop a solution; if it's not Arbitron expect them to fade into oblivion. In other words, do not touch the stock with your worst enemy's portfolio.

As local advertisers continue to turn to Pandora -- and away from terrestrial radio -- expect Pandora's local, regional and national sales figures to continue to explode. Looking at the Chicago numbers, courtesy of Miller Kaplan, via Radio-Info.com, can help us, at least roughly, get our heads around Pandora's potential in local.

Last year, the top biller in Chicago, All-News WBBM raked in $48.8 million. The top 10 stations in Chicago combined for $267.4 million in sales revenue. Robert Feder in Chicago notes that the market, as a whole, took in $439.744 million in 2011, up just 0.3% from the previous year. Clearly, advertisers are not bullish on terrestrial radio, but the industry still commands a pretty penny.

If Pandora takes just 1% of that total, it would reap about $4.4 million in ad dollars in Chicago alone. Remember, however, the company is just in the beginning stages of building out its sales team and disrupting the industry. Using a less, but still conservative share of 5% gives Pandora sales of approximately of $22 million in Chicago. That's nothing short of huge, considering I am low-balling the potential.

Keep two points in mind, though. First, you cannot just add these types of projections to Pandora's anticipated share of mobile ad dollars, as there will likely be considerable overlap, though I am not certain how much. And, second, if it performs consistently across markets, Pandora will likely bill more in New York and Los Angeles, but less in all of the markets that come in after Chicago in terms of size. Even so, simple and conservative math shows that the company has a multi-million, if not billion-dollar, opportunity in local sales.

As is the case at another company bears love to hate -- Amazon.com ( AMZN) -- keep today's numbers from Pandora in context. Long-term investors should focus on their assessment of where the company will be several years down the road. It's simply a question of Pandora's ability to execute its vision. The opportunity is clearly there for the taking.

At the time of publication, the author was long Pandora.

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