How a 'Speculative' Stock Became the Investment of a Lifetime

NEW YORK (TheStreet) -- Regardless of the stock, the majority of us participate in speculation when we make an investment. Some loose consensus of sentiment determines the degree to which one stock is more speculative than another.

You would be hard-pressed to find anybody willing to call McDonald's ( MCD) a speculative stock, even when it hit $100. It's a heritage company that continues to grow and pays a stable dividend.

Since hitting a 52-week high of $102.22 early this year, MCD is off about 14%. If you bought at or near the top, you speculated and were wrong. Does that make it a speculative investment? Probably not. Stocks tend to go up and down. This pullback should not surprise us.

But, what if MCD continues to go down or merely stagnates? At that point, does it become speculative in the widely-accepted sense of the word? Many investors would argue that it does not. McDonald's has a history of executing a proven business model. It's a blue-chip. That's fine; however, on the ground, it's still speculative. And if MCD stops generating meaningful returns, outside of the dividend hedge, its blue-chip status means little. On paper, it's no different than keeping dead money in Sirius XM ( SIRI) or going long a pharmaceutical that the FDA denies approval.

Pandora: No More Speculative Than McDonald's

If today, I was told I could only own one stock, I would select Pandora ( P). I would own it over MCD or any other name.

I am about to put my money where my mouth is. I'm getting set to go overweight the stock, turning it into the largest position in a portfolio that includes dividend payers in MCD's league, more aggressive dividend growth stocks, a non-dividend paying growth stock or two and more "speculative plays," ranging from Nokia ( NOK) to Zynga ( ZNGA).

For the sake of convention, I group Pandora with the Nokias and Zyngas of my portfolio. However, by the end of the month, it will take up about five to ten times more space in my account than any of the traditionally "speculative" names. And, at about a 10% weighting, it will be my biggest position by a small, but significant margin.

It's perfectly reasonable to ask why I am making this, by most observations, risky move. Heading into this week, I had fewer questions about Pandora's future than I did almost any other stock I own. After the events of this week, I have even fewer. And the questions that remain now come with a much clearer set of answers.

Pandora co-founder and Chief Strategy Officer Tim Westergren testified in front of a Congressional subcommittee this week on "The Future of Audio."

Westergren's testimony, coupled with a recent meeting I had with him at Pandora Headquarters in Oakland and news from Clear Channel ( CCMO.PK) this week, cement my ultra-bullish conviction. While it might not be the right play for you, for me, an investment in Pandora has, over the last year or so, developed into nothing short of the opportunity of a lifetime.

In many ways, P is the equivalent of Lululemon ( LULU) or Amazon.com ( AMZN) in their early days as public companies. Lots of bearish skepticism that refuses to rest, even as the stock soars. But, more importantly, companies led by bold entrepreneurs (Christine Day and Jeff Bezos) who would not look out of place drinking a beer or doing yoga with Steve Jobs just inside the pearly gates.

There's no question that Jobs would buy a round for Westergren.

At our meeting, I asked Westergren about the music royalties Pandora pays. He told me, in no uncertain terms, that Pandora likes the system the way it is set up. Pandora wants artists to get their fair share. He relayed this sentiment to Congress during his Thursday remarks:

Thanks to Pandora's Music Genome Project, and its rich understanding of musical recordings (every song in our collection is hand-analyzed by a trained musician along hundreds of musical attributes per song), Pandora now plays the music of over 100,000 artists (70% of them independent), represented by a catalogue of over a million songs ... For most of these artists, Pandora is the only radio play they've ever enjoyed. It is conceivable that this new promotional vehicle, if it continues to grow, may eventually lead to the emergence of a musician's middle class.

Westergren has big plans for not only helping create this "musician's middle class," but providing a promotional venue for acts large and small.

Pandora does not want to change the system. As Westergren told Congress, it simply wants a more equitable one:

Last year, on revenue of $274 million, Pandora paid $137 million in performance fees to performing artists and labels, or 50% of revenue. That same year, Sirius/XM, on revenue of $2.74 billion, paid $205 million, or 7.5% of revenue; and broadcast radio, on revenue of roughly $15 billion, paid zero. Now I am fully supportive of fair compensation for artists. I'm a musician, and I strongly believe that radio can and should reward musicians for the use of their work - both songwriters AND performers. But this lack of a level playing field is fundamentally unfair and indefensible.

I am not sure how any rational (or borderline irrational) human being -- be it a member of Congress or a suit on the Copyright Royalty Board (CRB) -- can look at those numbers and not agree with Pandora's take.

It's worth repeating: Pandora pays more than half of its revenues for content. Sirius XM pays less than 10%. Terrestrial radio pays nothing. However, in a not so small way, that changed this week.

Clear Channel CEO Bob Pittman struck a dealwith record label Big Machine that does the following: It caps how much money Clear Channel has to pay out when it streams one of the label's artists over the Internet in exchange for payment of an undisclosed amount when Clear Channel plays a Big Machine artist via traditional radio. This is nothing short of groundbreaking.

Of course, terrestrial radio advocates lament the move, chiding Pittman for, presumably, not consulting entities such as The National Association of Broadcasters (NAB) and for timing the announcement just before the hearing on Capitol Hill. These complaints further prove how out of touch many traditional radio broadcasters are.

To clue you in on Pittman, he founded MTV. I guess that makes him just somewhat relevant and a bit of a visionary.

Pittman realizes that music listeners will continue to migrate away from broadcast radio stations to streaming delivery. Every minute of every single day on hundreds of stations across the country, Clear Channel leads the charge, as it promotes its iHeart Radio app incessantly. Pittman is setting the company up for a smooth transition and a more workable deal once a majority of Clear Channel listening goes digital.

Whether he wanted to or not, he just set the table for a better deal for Pandora.

Pandora does not play songs over traditional radio; therefore, it cannot use that as leverage for more sane royalty rates. It does, however, dominate Internet radio. When it lays out the current disparity in payments and points to its leadership position as the future of audio, there is no way Congress or the CRB would have the nerve to make Pandora pay a penny more in digital royalties than Clear Channel, Sirius XM or any other radio broadcaster.

That means a drastic decrease in expenses and, amid continued hyper growth, a stratospheric rise in the stock price.

Pandora's current royalty deal goes through 2014. While not impossible, I doubt it could open up for renegotiation. We could, however, continue to receive more color on what's likely to happen, just as we did, in droves, this week.

That's fine by me. I will be accumulating the stock at any price.

At the time of publication, the author was long NOK, P and ZNGA.

At the time of publication, the author was long NOK, P and ZNGA.

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