Pandora: A Buy On The Dip?

Chris Lau, Kapitall: News that Apple (APPL) will release iRadio services caused shares in Pandora (P) to decline. Apple reportedly has a licensing agreement with Warner Music, and is working to get one signed with Sony (SNE) and Universal Music. Pandora has an amazingly large user base of 200 million. 140 million accessed Pandora on a mobile device. 200 million songs are streamed before 10 a.m. (More articles from Chris Lau: 4 Things To Look For Before Iron Ore Bottoms)  

What is the real risk in the business model of Pandora? Is Apple a real risk to the ad revenue model for Pandora?

Pandora outperforms Apple

Apple is no threat

Apple’s iRadio is not a threat for Pandora, since the service will only work in Apple products. Pandora has an established customer base who already invested time in building music lists. Customers enjoy limited commercials and would need to acquire an Apple product to use the iRadio service.

The high usage of Pandora is like a gold mine for advertisers. Pandora applies information supplied by its users to effectively target advertising based on gender, age, and location.

iRadio strengthens App store moat

An iRadio service is likely to gain a substantial number of users within the first few days of a release. If the interface is as good as other Apple products, which is very likely, then Pandora will lose many users after the iRadio launch. More importantly, if the monthly cost of service is negligible for Apple users, it would ensure product loyalty for Apple. This would be another reason for Pandora users to switch to iRadio.

High royalties

Pandora already locked itself with high royalty fees. In the first 10 months of 2012, 60% of revenue was spent in music royalties. The average satellite radio service, which includes SiriusXM ( SIRI), pays out only 7.5% of their revenues for royalties.

The high royalty costs need not be negative. Artists might prefer to have songs played on the service, because Pandora links songs being played to online stores. This encourages users to purchase the music.

Conclusion

Bearishness in Pandora is already high. The short float is now over 30%, rising steadily since the company reported quarterly earnings last month. Pandora could move even lower if iRadio is confirmed at Apple’s Worldwide Developers Conference (“WWDC”), which takes place between June 10 to June 14, 2013. It is not a good idea to think that Pandora will stop innovating its services. The market was large enough for Google to enter the streaming audio market. An Apple iRadio will be just another streaming audio service. A drop in Pandora shares gives investors another opportunity to build a position in the company.

Written by Chris Lau, Kapitall Contributor

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