Thirty days of buyout drama for Pandora Media Inc (NYSE:P) stock come to an end on Thursday. And while the result sent Pandora stock higher in morning trade, the news is middling at best — a “tie” when P was looking for a win. Namely, Sirius XM Holdings Inc. (NASDAQ:SIRI) could be investing in Pandora, but it won’t be buying it.
In early May, Pandora released disappointing Q1 earnings. It also announced a $150 million investment from KKR & Co. L.P. (NYSE:KKR), the famed private equity shop.
That investment had two key clauses, however. First, Pandora had 30 days to find another company interested in buying out Pandora stock. Second, the company could raise another $100 million on the same terms from a different investor.
And so, for the last month, the acquisition rumors which normally swirl around P stock have only intensified. Long-cited buyer Sirius XM was reported to be making a bid. The New York Post then claimed this week that Verizon Communications Inc. (NYSE:VZ) would invest $100 million if Siri couldn’t get Pandora to take an offer of $11-$12 per share.
All the while, Pandora stock kept falling.
P stock closed regular trading the day of the earnings release at $10.40, having already lost 20% YTD. Pandora has declined another 18% since the report.
Shares are up Thursday, perhaps more in relief that there’s any sort of resolution, but not on optimism of the result. According to a report from Reuters, Sirius XM was unable to come to terms with Pandora on a deal price, but it is negotiating a deal to invest in Pandora; presumably the $100 million per KKR’s terms, but it could be more.
But I say that investment isn’t good news for P stock — not even close.
The Sirius Deal Isn’t a Good Deal
It might appear that the investments from KKR and Sirius should be bullish for P stock. I’m skeptical that’s the case for two key reasons.
First, the terms of the investments aren’t great for Pandora. KKR and Sirius each will receive preferred stock that pays 7.5% interest in cash, or 8% if paid in kind (i.e., more preferred stock). Pandora can choose, and almost certainly will choose paid in kind, given that it needs the cash. The preferred stock can be converted into common stock at $13.50 per share.
Even though the investment is considered preferred stock, it’s much closer to a debt financing at an effective double-digit interest rate — with the added problem of diluting Pandora stock holders. KKR and Sirius are getting a good deal, not necessarily buying a stake in Pandora simply because they like the company so much. (They could have bought common P stock on their own in that case.)
To be fair, Pandora is getting some perhaps much-needed expertise in the deal. But all else equal, Pandora investors should prefer the company raise debt instead of equity.
The second problem is that Pandora didn’t sell itself, which is what many P stock holders and traders were hoping for. That’s a long-term problem, too. Sirius remains not only the most obvious buyer, but might be the only logical one. Private equity firms don’t buy businesses that can’t even create positive free cash flow. Tech giants like Apple Inc. (NASDAQ:AAPL) and Amazon.com, Inc. (NASDAQ:AMZN) have their own streaming and/or on-demand services.
So if Pandora won’t sell to Sirius and it won’t generate any cash, when — and how — can shareholders expect to realize any value from Pandora stock?
Paying for Pandora
The problem for P stock is that its bull case largely was based on a takeover.
It has an impressive platform, a large subscriber base and valuable intellectual property. But it can’t make any money. Earnings are sharply negative even on the EBITDA line, and even excluding share-based compensation, which totaled ~$250 million in 2015 and 2016 alone. Pandora continues to burn cash — one reason it needed the financing from KKR and will take another investment from Sirius.
And all accounts appear to confirm that Sirius would have taken out Pandora — for the right price. Maffei told a conference in March that Sirius “probably” would acquire Pandora if it could do so for $10. It reportedly offered $15 per share last year. It certainly sounds like Pandora wanted $16-plus, and Sirius wouldn’t budge off a low double-digit offer.
With Pandora stock at $8-plus, that seems a little greedy. But it also raises the question of what happens now?
What’s Next for Pandora Stock?
Pandora’s only play from here is to prove Sirius XM wrong. It needs big success with Pandora Premium. That means enough success to convince Sirius to up its offer to the range Pandora’s board is targeting and enough to offset the dilution created by the KKR stake.
There really aren’t any other paths to upside for P stock. Pandora isn’t going to suddenly turn profitable. Even a successful launch of Premium will take time to ramp – and time for new subscribers to offset start-up costs. No one else is buying Pandora any time soon, particularly after it spent a month publicly on the block.
Meanwhile, the most prominent pillar of the bull case for P stock — that Sirius would buy Pandora eventually — is damaged. If Pandora struggles, and particularly if Premium disappoints, Sirius won’t throw good money after bad.
That would worry me if I owned Pandora stock. Essentially, staying long P here is a bet on management. It’s a bet that management was right to turn down Sirius’ offer. And it’s a bet that a company that hasn’t executed, and hasn’t made a dime, will start doing at least one of those two things.
It doesn’t sound like a bet worth taking.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
