Should You Buy Pandora Ahead of Earnings?

NEW YORK (TheStreet) -- The day before Pandora's (P) last earnings report, a Stifel Nicolaus analyst came out with an obscenely bullish report, setting his price target for the stock at $18.

Here's how I responded at the time over at Seeking Alpha:
"Heading into the report, I am not nearly as bullish, but you must consider my perspective. I own Pandora for the long term. What happens tomorrow matters, of course, but it's very unlikely that anything I hear tomorrow will shake me out of the stock."

I feel the same way heading into Wednesday afternoon's earnings release.

I have been buying Pandora stock since last year. I own a consistently growing number of shares at a cost basis of $10.15. Because I am confident that Pandora will not drop any negative bombshells after Wednesday's close, I intend to stay the course.

That said, only you can answer the question of whether you should buy Pandora ahead of the report. I bought more shares on Tuesday, but that's my regular modus operandi. (I buy shares on two to four Tuesdays a month.) I am a long-term investor who feels like he understands what Pandora is trying to do over the long haul. Short-term noise concerns me very little, if at all. I bought at $15-16. I bought at $8-9. And I bought at many points in between.

So you cannot make this decision on the basis of what I do. First of all, you need to conduct your own due diligence and come to the same or similar conclusions as I have -- on your own -- but aided by the things you read on the bull and bear side. Second, you have to make sure your portfolio has room to stomach a volatile stock of Pandora's nature; it could give back every cent it gained over the last month in after-hours trading tonight on a poorly received report.

With companies like Pandora (and Facebook ( FB)), I tend to look primarily to the future. Near-term noise and headwinds mean very little, if anything, in the grand scheme of things.

Here, ahead of the report, I consider some of the key concerns that could interfere with Pandora's forward-looking narrative.

Competition

Many Sirius XM ( SIRI) permabulls like to argue that the company has no real competition. Some go so far as to say Sirius XM enjoys a monopoly because it is the only satellite broadcaster of record. That's an absurd argument.

In the new media space, I define two types of competition: direct and indirect.

From an indirect standpoint, anybody fighting for your ears (and eyes) represents competition. If I choose to queue up a series of songs via YouTube videos, Google ( GOOG) has one-upped Pandora and any other choice I could have made to spend my time.

When I fire up my Roku Player and dial into Prime Instant Video as opposed to kicking back with tunes from Pandora, Amazon.com ( AMZN) adds a notch to its bedpost.

From a direct standpoint, it's difficult to make the case that a company fighting primarily for your ears competes with one after your eyes. As such, I would argue that radio competes with radio (terrestrial vs. satellite vs. Internet), but that does not mean they cannot coexist. They do and will continue to do so for some time, if not forever. Some competition is more direct than others.

Pandora faces loads of competition. Some of it head-on. It runs in one of the most competitive spaces out there. But, it dominates that direct space (Internet radio) and continues to gobble up market share in the broader space as it now accounts for 5.95% of all radio listening.

Ken Dardis made solid points in his excellent industry newsletter :
"iHeartRadio boasts reaching 10 million registered users. I should hope it has. Clear Channel has over 800 radio stations promoting this app. Online, the trick is to reach that number without being aided by huge amounts of promotional time. (Spotify is at 10 million, with no radio ad support.)"

To get to where it has, Pandora has had to endure attacks from Clear Channel and the rest of the terrestrial radio lobby. Dardis continues:
"If the radio industry is to remain relevant it needs to create items of relevancy. Instead, what we have is a continuous stream of denying there's a problem, and even more evidence of staying the course."

And there's additional evidence of an entire industry running scared. The more terrestrial and satellite radio brands Pandora inferior, the more it attempts to emulate it. iHeart Radio is little more than a Pandora knock-off, and Sirius XM's Mel Karmazin plans to introduce some form of "personalized radio" later this year.

Competition exists, no doubt. Some of it, like Spotify and iTunes, is complementary, while other examples, such as iHeart and Sirius XM's forthcoming features, are complimentary.

Growth vs. Content Costs

This is probably the most misunderstood area of Pandora's business.

First, growth will moderate. It has to. Pandora cannot and will not penetrate the entire available market. As that growth moderates, content costs stabilize. At the same time, expect to see the company's rapidly expanding cross-platform sales efforts continue to drive revenue growth. Ultimately, that's the path to profitability.

I can tell you with 100% confidence, Pandora has won and continues to win considerable ad buys from clients who would have, prior to digital's emergence, spent their money elsewhere. Some of these accounts have been some of terrestrial radio's most loyal and consistent revenue sources.

Clearly, as it commits more than 50% of its revenue to cover music royalties, Pandora wants a more equitable deal. And it will seek one and likely argue that terrestrial radio should start paying its fair share.

For as outrageously screwed up as the entire royalty scheme is, Pandora likes the general concept. The company champions all musicians, particularly indie artists fighting to be heard, and it wants them to get paid. That said, it will leverage it's growing foothold on music listeners in an attempt to level the playing field come 2014-2015.

That's really the time frame I use as a long-term investor for when I expect Pandora to deliver meaningful results as an investment. Meaningful long-term narratives do not play out overnight. As such, what happens on earnings tonight or in three months means little in the big picture.

At the time of publication, the author held long positions in FB and P.

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