Pandora Media Inc (P): A Good Short Candidate

Yesterday, Pandora announced that it has decreased the amount of music a user can listen to on Pandora. Previously an unlimited amount of music was available to listeners, but now it has been capped at 40 hours. According to reports the per track royalty rates of Pandora have increased by a staggering 25% in the last three years. Tim Westergren has disclosed in a blog that these rates might increase by a further 16% in the next couple of years. Although, this might seem a major cut, according to the company website only 4% of users will be affected by this 40 hour restriction. These 4% can once again get the unlimited access by paying only 99 cents for the rest of the month.

Bottom line

The company is operating in a very tough macroeconomic environment where businesses are facing advertisement cuts. Pandora faces tough competition from its competitor Sirius XM Radio Inc (NASDAQ:SIRI). Sirius has reported a 5 year average sales growth rate of 30% compared to only 21% for the industry. It has also doubled its EPS y/y and reported an EPS of $0.025 in the quarter ending December 2012. Due to its lower content acquisition costs it has a much more sustainable business model. The company has a pretax margin of 13.9% versus only 7.7% for the industry.

The analysis shows that there is no justification to the recent 40% rally in Pandora’s stock price. The company is operating in a highly competitive market and has the disadvantage of higher content acquisition costs as compared to competitors. The stock is also trading at a 10% premium to the mean sell side target price of $11.21. Therefore, I recommend investors short Pandora as the stock is overpriced at these levels.

The article A Good Short Candidate originally appeared on Fool.com and is written by Mohsin Saeed.

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