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Pandora is Not A Start-Up Anymore

April 21, 2015

Two interesting Pandora stories broke in the last couple days:  Morgan Stanley projects a no-bubble price target of $2-$3 a share for Pandora with an “onerous” (meaning fair) royalty set in the Webcasting IV proceeding currently underway, and Roger Faxon joined the Pandora board.

According to analysis of Morgan Stanley’s stock analysis:

Swinburne noted that under the most bearish case, the CRB takes its existing rate structure (not Pandora’s current lower rate) and grows it 10 percent in 2016 and 5 percent per year from 2016 to 2017. This essentially eliminates any adjusted earnings at Pandora until 2021 and creates a funding need of around $350 million until reaching free cash flow positive. [“free cash flow positive” means that operating cash flow minus capital expenditures is a positive number–Pandora has never been free cash flow positive so not sure why this is the benchmark Morgan Stanley is using.]  Under this scenario, the analyst suggested shares of Pandora could be valued at $2 to $3 per share.

Just to inject a touch of reality here, Pandora has never been free cash flow positive since its IPO and may never have been.  So if it won’t be free cash flow positive until 2021 and hasn’t ever been–then why isn’t the stock valued at $2-$3 per share now?

If a company is trading at $17 a share and its true value is $2 a share, there’s something creating that $17 bubble price.  If it’s a true bubble, then it’s just more Dot Bomb BS.  So what could be creating that additional value?  To be fair, it is in part Pandora’s technology or the enterprise value of the company.  If that were true, then how does Morgan Stanley get to a $2 share price if Pandora’s statutory recording license was fully valued by the CRB?

So maybe what makes up that $15 per share delta is something else.  Maybe it’s the value of the music, both the recordings and the songs.

Maybe it’s the net present value of all the billions of promotion and marketing dollars, touring, merch, A&R and songwriting that artists, songwriters–the freaking effort–that has gone into producing the history of recorded music that the government forces us all to let Pandora use.  Remember–Pandora channels are created by users who already know who the artist is they seek.   How do users know that?  Because of Pandora?  Nope.  Because Bruno Mars is already famous because of Bruno Mars, his label, his songwriters, his publisher.

Let’s get this straight–what drives traffic to Pandora is the same thing that drives traffic to all these online companies.  Fans who are already fans looking for music by artists who they already know.  And the a priori reason that the recordings are popular is because of great songwriters telling compelling stories in new ways.

While we constantly hear how much promotion value there is from Pandora, let’s not forget that is a two way street.  Did Pandora start the music genome project with songs by unknown artists from pre-gentrification Emeryville?  No.  They started with the hits.  And they did that for a reason that did not cost them a nickel.  They did it for $15 of share value.

So let’s put Morgan Stanley’s $350,000,000 funding need in perspective.  At Pandora’s current share price, that’s about 21 million shares or roughly the share value of all insider trades by Pandora’s senior executives and board members.  So one reform that Roger Faxon could start with would be executive compensation–a topic he’s very familiar with from his EMI days.  Why are all these insider people making all this money when their company is actually at a $2 share price?

Most financial analysts look at Pandora’s royalty payments and think the payments are too high because analysts are trying to justify the continued existence of the stock they follow and–let’s face it–they are trying to flog the companies stock to customers.  The reality is that they are looking at the wrong cost item.

As Roger Faxon well knows, the way to get profits up is to get variable costs down–starting with executive compensation.  Royalties are the cost of an input and bring substantial promotional benefits essentially for free.

Bear in mind Mr. Faxon is not a manager of the company, so let’s not attribute to him executive powers.  But he certainly can sit across the table from Pandora’s CEO Brian McAndrews and tell him his salary is too damn high.  Because Mr. Faxon knows that if he’s going to ask songwriters and artists to share the pain, sharing starts at home.  Mr. Faxon knows full well that he has a long, long, long way to go to overcome the disaster that Pandora has created in the artist community and especially the songwriter community.

I firmly believe that I could add 5% to Pandora’s bottom line in an afternoon simply by cutting executive compensation in the senior management team.  If I can do that, Mr. Faxon should be able to find 20%.

If you are a student of history, you will remember that the Battle of the Somme–the most disastrous battle in the history of the British Army if not human history–actually had a plan.  (Churchill would have preferred “offensive siege” to “battle.”) Some generals somewhere actually thought this was a good idea. Just like someone at Pandora thought this debacle was a good idea.  Pandora is not a startup anymore, and it needs to stop being run like one.

So Mr. Faxon has a choice–either he can continue Pandora’s march to oblivion according to whatever battle plan their generals have cooked up and cash out as fast as he can before the bubble bursts, or he can start being a change agent.

You know–disruptive.

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