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Pandora Crashes, but Is It Dead?

Rocco Pendola | Director of Social Media
Wednesday, 5 Dec 2012 | 11:25 AM ET
Source: Pandora

Pandora reported a quarterly profit. And nobody cares.

That's because the company slashed fourth quarter guidance, citing concern from advertisers over the fiscal cliff.

Of course, this turn of events — as is protocol — led Pandora's stock to crash. If history repeats, it will rebound over the next several weeks until something else "bad" happens — say Apple launching iRadio -- only to crash again.


This is a fantastic day trader's or swing trader's stock. Unless you have a world of patience, an ultra-bullish take on Pandora's future and, preferably, more-than-average covered call writing capability, Pandora is an awful stock for most long-term investors.

It requires nerves of steel and sleeping pills; two things your financial advisor — even if the little man inside you plays that role — should never have to prescribe.

It's not dead, but, listen, you either need to trade this thing or own it for another one to three years, knowing full well that it's a classic case of massive risk in exchange for an only halfway decent potential for massive reward. That's the definition of a highly speculative stock that should comprise a very small portion of your portfolio.

That said — there might not be a more misunderstood company than Pandora. Last night, I followed the earnings postmortem and not one bit of it gets past the standard focus on short-term noise.

The problems Pandora faces out on sales calls, re: the fiscal cliff, are real. This is exactly the type of holdup the gridlock in Washington causes. While I don't agree with decision makers who use the fiscal cliff as an excuse not to invest in their businesses — in fact, I think they're losers — the reality is what it is. This thing puts a drag on economic expansion.

But, that's part of the noise. It's temporary stuff. It says nothing about Pandora's business model, which, by and large, works.

The company continues to pioneer mobile monetization alongside the Twitter powerhouse and Facebook's emerging platform.

Mobile revenue was up 112 percent year-over-year to $73 million for the third quarter.

Listener hours continue to soar, as Pandora now commands 7.09 percent share of all radio listening, up from 4.32 percent the same time last year.

Pandora and Music Royalties

The fly in the ointment — content acquisition costs. For Q3 — and all of this data is available at Pandora's investor relations website — Pandora paid close to $66 million in music royalties. That's roughly 55 percent of revenue.

I have published several articles on the fight that's happening in Congress. I will continue to write about it, but it takes more than one article or a sound bite to make sense of such a historically rooted, emotionally charged and complex issue. It needs to be a conversation. One that requires patience and is comfortable calling it a night with unanswered questions lingering.

I will tell you this — 99 percent of what gets reported about Pandora, Spotify, and music royalties is either wrong or flat out irrelevant.

This entire thing comes down to a fundamental disagreement between the music industry and Pandora. I require an entire weekend to sit and write one long article fleshing the whole thing out, but know this — the music industry does not have the interests of any party other than itself (including the artists it "represents") in mind.

This comes down to a fight between compulsory music licenses (the route Pandora takes) and direct negotiation with the labels (Spotify).

Thanks to a dearth of in-depth reporting and an abundance of noise, nobody knows what the hell they're talking about.

Compulsory licenses are better for artists and they're better for the music listener.

Under a compulsory scheme, Internet radio players such as Pandora do not need permission from a label to play its music. Pandora can choose from the entire universe as long as it abides by some limitations and pays what are now exorbitant royalties to SoundExchange, which splits the cash with artists.

Pandora does not need to negotiate short-term Netflix-type deals with the labels like Spotify does. It does not have to chase down every small label and artists in the country and cut a deal to play their music. That's not possible, which explains why Pandora has incredible variety and, relatively speaking, Spotify has none.

Music labels want Pandora to charge a subscription fee and enter direct licensing agreements. Of course that's what they want because that puts more money in the music industry's pocket and less in most artists' bank accounts. Plus, it makes Internet radio an impossible business.

Stress this: The ONLY way forward is a compulsory license scheme where, across platforms, everybody pays something close to the same amount. One company cannot continue to pay 7 percent of royalties, another 15 percent and another 55 percent. It's just absurd.

That's the answer. Moving to a subscription-based model like Spotify is absolutely not the answer. It would be a disaster for everyone — the business and the consumer.

You cannot scale a subscription model like Pandora has scaled and continues to scale the free model. Spotify proves that. Look at how much it has spent, yet it has barely made a dent in the U.S. market. Without scale, you can't sell advertising; without advertising, you don't have a business.

Pandora has scale at 59 million active listeners in the U.S. only. Spotify has no scale at 15 million listeners worldwide.

We're approaching pivotal times in what comes down to a battle between compulsory versus direct licensing and a war of two different world views.

Ultimately, as Pandora's market share continues to grow, traditional radio's footprint gets smaller and Spotify's deficiencies go public (that love affair is about to end), Pandora — not the music industry, not disingenuous Clear Channel and surely not Spotify — has the edge.

The labels will not win this fight. Pandora's on the right side. As its popularity grows, so does its leverage. As Pandora makes its case in Congress and people such as myself spend weekends writing about the issue, that will become clear.

Interesting stuff to talk about. Fascinating actually. But, with relation to the stock, it's even noise. At least right now.

The stock stinks unless you trade it nimbly or really love it and salivate at "cheap" shares. I would not touch it until Pandora retakes control of the royalty conversation in Washington.


—By TheStreet.com's Rocco Pendola

Additional News: Spotify in Top League With $3 Billion Valuation


Additional Views: Short Amazon: Do You Have the Guts?: Pendola

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TheStreet's editorial policy prohibits staff editors, reporters, and analysts from holding positions in any individual stocks.

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