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Pandora Hits a High Note … But Don’t Join In

The company has a strong quarter, but still isn't profitable


Pandora (P) is having a pretty good Friday. The streaming music service just reported first-quarter earnings, including a whopping 55% increase in revenue that brought its total to $125.5 million. That was above the street consensus estimate of $123.8 million.

Of course, profitability is still elusive. In Q1, Pandora sustained a loss of $28.6 million, or 16 cents a share. And even when adjusted for one-time items, there was still a loss of 10 cents.

Investors don’t seem to care, though. Apparently encouraged by the overall strong growth on the top-line, the stock jumped around 7% early this morning — hitting a 52-week high before falling off slightly.

One reason the company’s sales — and thus its stock — are on the way up? The growing shift to mobile. Pandora now has about 200 million registered users — many who love the service — and over the past year, the quarterly listening hours increased by 35% to 4.18 billion. Nearly 80% of that growth was from mobile devices.

What’s more, the efforts — including Pandora’s 40-hour mobile listening limit — to get those loyal users to buy subscriptions are also working. In the prior quarter, Pandora added 700,000 net new subscribers, reaching a total base of 2.5 million.

Despite all this, I recommend that investors remain cautious. Pandora faces some tough competition considering that Google (GOOG) recently launched its own music service, which is available on the Android platform, and it looks like Apple (AAPL) is also working on something similar for iOS.

And those competitors come on top of fierce names like Amazon (AMZN), Spotify, RDIO, Slacker and Rhapsody.

Another worrisome factor for Pandora: its business model. The big problem is that the company has onerous content agreements with the record labels. The way things stand now, costs represent a whopping 66% of sales. This will make it extremely tough for Pandora to reach profitability, especially since the company is still investing aggressively in sales, marketing and R&D.

Besides, the company’s shares have already been on a tear lately, nearly doubling in 2013 alone. And if Google and Apple begin to get traction with their services, the growth could taper a bit, which could make the stock price vulnerable.

For investors, it’s probably best to stay away from Pandora for now.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO StrategiesAll About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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