Pandora Pre-IPO Preview

Positives

 

+      Pandora is a very easy to use service. This is critically important in the consumer technology market and can hardly be emphasized enough.

+      Although the “Music Genome” approach that Pandora has pioneered has its critics, it does make it very simple for a new user to declare some of the music they like and then enjoy a listening experience that includes both favorite music and new discoveries.

+      The market is large with some rapidly growing segments like iTunes and advertising-supported digital radio.

+      Pandora is the market leader in the streaming, advertising supported segment.

+      Getting the user experience right takes some doing and Pandora has executed well so far and has the resources to develop the necessary technology and services that keep users engaged and happy.

+      Music has been in the cloud for a long time (radio!) and is an ideal application for true cloud-based offerings.  Pandora’s architecture and approach is more cloud-focused than many others’.

+      The management team has an excellent mix of backgrounds and experience, including: consumer marketing, cloud computing, online commerce, Internet business, legal affairs and music.

Neutrals

=   Fees paid for content are still a fairly high percentage of sales and are basically going up on a per performance rate.  Pandora may still have the ability to bring the costs down as a percentage of sales as they scale.  The rates are set through 2015 after which point a new agreement will be needed.

Negatives

–      The obvious one here is competition, especially with Apple and Google controlling much of the mobile Internet consumer market.  If they launched strong offerings for iOS and/or Android respectively, it would take away some market opportunity for Pandora.

–      Making matters worse, the competitive barriers in the business are basically nil.  Pandora has strong technology but virtually no lock-in.  Although they have some advantages to being included in consumer devices it’s not a lock-in like iTunes.

 

Background & Context

 

What was previously known as the “music business” is shifting radically into consumer business.  The transition is causing established players to suffer and scramble to cope with the changes.  The market has been shifting more quickly than their ability to move.

Music has been delivered via an “analog cloud” called radio for a long time.  Even today most music is consumed this way but the “radio” is shifting from analog to digital.

Pandora is generally recognized as a pioneer and leader in streamed music content; or, as they call it, “Internet radio.”  The company has 80 million registered users and a 50% share of Internet radio listening in the U.S.  Pandora started in 2000 with an innovative idea called the “Music Genome Project,” which is an algorithmic analysis of music to enhance the listening and discovery experiences of music.  In 2005 the company launched their free service for consumers.

The company strategy has been to deliver their value as a service and allow consumers to access their Pandora stations on any platform, including computing devices including tablets and smartphones, and in cars and consumer audio systems.  Pandora is accessible on virtually any connected device.

By leveraging digital delivery and the Internet, Pandora has been able to deliver a more effective audience for advertisers and a better ratio of content to advertising for listeners. The situation is analogous to how digital content-based advertising has impacted newspapers.  This advertising model is driving major revenue growth. Revenue grew from $19m in fiscal 2009 to $55m in fiscal 2010 and should exceed $100m for fiscal 2011.

The Pandora IPO will help catalyze an intense battle for online music in 2011.  Apple stands in the strongest position but Google, Amazon, the music industry and even consumers may be eager to see successful alternatives.  In addition to Pandora, companies like Spotify, Sirius/XM, Rdio, MOG, Kazaa, Last.fm, RealNetworks, Beyond Oblivion and dozens of smaller companies are vying for a piece of the action.  Individual and syndicated stations are also implementing their own digital strategies.  Recently Bob Pittman of Clear Channel noted that they would push into the digital space and had the advantage of over 200m listeners.

This topic deserves a full-length report but for now what follows is a short take on the Pandora IPO and some notes on industry dynamics and the other players.  Indeed, the royalty structure and economics alone could occupy an entire report, if not a book.  We’ll touch on them and of course they are incorporated into our financial models through 2015, at which point most existing licensing terms and agreements end.

 

Stock and Valuation

Pandora has only filed a preliminary prospectus that lacks a few details we need to compute a per-share Intrinsic Valuation.  However, we can estimate on a preliminary basis an IV of $700m to $1B.

The preliminary IV model is attached. The per-share figured should be ignored.  Our final report will include an updated version, a peer analysis and a more detailed model of the business.

Conclusion

Many investors, particularly institutions, remain wary of investments in entertainment companies. But at the same time they find it hard to resist large revenue growth in an area where big players, including Apple and Google, have strong interests.

Pandora has some key advantages over competition in the consumer experience and in monetization.  This puts them in a good position in terms of the ad-supported streaming business.  Early enthusiasm might push the shares beyond our IV estimates.  After an updated prospectus is filed and the deal begins active marketing we will update our financial models, IV and this report.

[The report in PDF form is available to Toffee subscribers on the Research Reports page.  When we update the report with the final IV, peer analysis and detailed financial we will send out notification to the Toffee group.]

[Disclosures: None]

Related articles

• Pandora and the Final, Crucial Internet Radio Frontier: The Car (TCTV) (techcrunch.com)
• The great online car-radio race (tech.fortune.cnn.com)
• Pandora looks beyond music in IPO (slashgear.com)