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

by Tom Taulli | May 24, 2013 11:10 am

Pandora (P[1]) 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[2]) recently launched its own music service, which is available on the Android platform, and it looks like Apple (AAPL[3]) is also working on something similar for iOS.

And those competitors come on top of fierce names like Amazon (AMZN[4]), 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[5]. He is also the author of High-Profit IPO Strategies[6]All About Commodities[7] and All About Short Selling[8]. Follow him on Twitter at @ttaulli[9]. As of this writing, he did not hold a position in any of the aforementioned securities.

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