That’s the question Frank DiPietro of financial advising blog The Motley Fool sought to answer Friday (3/30).
In a comprehensive review of the streaming audio company’s financial health, DiPietro put on his thinking cap and wondered if Pandora Media is better off without a merger with its much-discussed potential suitor, Sirius XM Holdings.
Following a March 6 declaration at the Deutsche Bank Media, Internet & Telecom Conference from Liberty Media Corp. Chairman of the Board Greg Maffei that Pandora’s stock is overvalued and, therefore, “it’s very unlikely” a deal will be done, Pandora shares dipped more than 6%. They remain at or near these levels and as of 3:09pm Eastern on Friday were at $11.90.
What’s “interesting” to DiPietro is the retention of some 8.8% of all Pandora shares by Corvex Management, a hedge fund that is seeking changes to Pandora Media’s board of directors … for starters.
Corvex has been lobbying for a sale of Pandora for a year, when it started buying up shares in the company. “One way activist investors attempt to influence a company’s actions is to buy enough shares to demand seats on the board,” DiPietro notes.
On March 16 Pandora announced it had pushed its date to nominate potential new directors out by two weeks to March 31, “likely in response to Corvex’s desire to propose new board members in what could be a developing proxy fight,” DiPietro said ahead of a second extension approved March 30 that sets a new date of April 14.
With “all this saber-rattling and jostling for control, it’s easy to forget about the actual business and what Pandora management is trying to achieve,” DiPietro reasons. So, he reviewed the company’s growth plans, noting that revenue is estimated to reach $4 billion by 2020; Pandora saw $1.36 billion in revenue in 2016.
What’s Pandora worth? Its market cap stands at $2.8 billion. It has revenue of $1.38 billion. Thus, Pandora trades at two times sales.
“If management is able to deliver on its promise and deliver $4 billion of revenue by 2020, we can generate a basic prediction that the company will be worth $8 billion by that time,” DiPietro says.
The table below compares the price-to-sales ratio between Pandora and Sirius XM:
So, what’s a shareholder to do? While Sirius XM has debated Pandora’s enterprise value of $2.86 billion, it is close to DiPietro’s calculation — valuing the company at two times sales.
Therefore, he opines, “If a shareholder looks at the potential for Pandora to make money in the future, they may fall more in the camp of Corvex, who believes the company is undervalued at today’s stock price. If the company executes its plan, it will be a profitable business in 2020. With a 15% operating margin on $4 billion of revenue, $600 million of operating profit would be quite the feat for a company that has reported losses for every year as a public company.”
But, the key question is whether or not Pandora is overstating its 2020 revenue projection — something DiPietro doesn’t bring up.
Rather, he says, “there is a fundamental challenge to the on-demand music streaming business, which is the cost of the content. Both Spotify and Pandora have to pay the artists and music labels each time an on-demand subscriber plays a song. Pandora estimates this cost at 63% of subscriber revenue, while Spotify is paying out nearly 70% of revenue for music-licensing contracts. This may ultimately put a cap on the ability of all businesses in this space to be successful.”
All things considered, DiPietro advises Pandora shareholders to “simply do nothing” and hold their stock.
“If Pandora management successfully executes its long-term vision, the company will finally find itself in the black,” he says. “There is also the possibility that activist fund Corvex will push for a tie-up with another company. In any case, 2017 should be an interesting year to follow Pandora, and I’ll be along for the ride.”