Saturday, February 12, 2011

Pandora: A Good Bet for Wall Street?

With an IPO currently scheduled for later this year, is Pandora sexy enough to attract investors?

This week, Internet radio company, Pandora, filed its application to sell stock to the public.  If you read between the lines, the application may be more of a publicity move than a financial milestone.

There is no doubt that Pandora could use the $100 million it hopes to raise.  The company is still struggling to become profitable.  And therein lies the conundrum.  Investing in a losing venture only makes sense when the capital infusion will turn the company around.  But I don't think Pandora is struggling because it lacks money.  The problem seems to be its business model.

Pandora's competitive advantage -- the strength which it sells to consumers -- is its psycho-tech music measurement software.  It is something out of a science fiction movie -- software that allegedly understands exactly why you like particular songs.  The theory is that Pandora can turn every listener on to more music that is exactly what he or she wants to hear.

I'm not even going to argue whether the software works.  I'm willing to assume that it does -- at least to some degree.  If they work that hard to analyze the music I like, they can probably find some more songs that will appeal to me.  The issue is whether anyone will ever pay for that service.  Unfortunately, I don't think so.

I think all of us like to discover new music in a more organic way.  We ask our friends or simply stumble across it.  In fact, I think we enjoy the process of listening to something and deciding whether we like it or not.  We don't need the pressure of software telling us that this is music that is scientifically matched to our tastes.  I personally don't like to think of myself as being that predictable -- even to a computer.

And even if I like the idea of getting a bunch of new music chosen (if computers actually "choose") just for me, I can't see paying for it.  I'll subscribe to Netflix for 8 bucks a month, but not to Internet radio -- no matter how smart it is.  And that's why Pandora is free, and why it will probably continue to be free.

That means that its only likely real revenue source is some version of an ad-based model.  It might find its way to profitability by selling ads, but I don't think it will enjoy explosive growth.  And with music royalties and other costs likely to increase, the road to profit will only get steeper.  (In fact, Pandora is apparently no longer available in Canada because the music license fees were too high.)

Pandora is certainly getting a lot of buzz.  It now has over 80 million users and is constantly mentioned as one of the hottest companies on the Internet. By filing for an IPO, it is trying to tell the world that its momentum will eventually lead to riches.  Personally, I just don't see it.

Without a huge upside, there is probably not a lot of incentive for investors to jump on board.  The idea of investing in an Internet stock is to bet on the home run, and Pandora doesn't seem to have enough power to hit it out of the park.  

I'm open to other points of view.  Let me know if you think I'm missing something on this one.


James said...

Roger, I agree that Pandora stock would be a risky investment and is probably not a good bet for Wall Street. They have built tremendous goodwill. I often ask people how they get their music and an overwhelming majority of them say Pandora. But if statutory royalty rates go up and new competitors offering free (ad-based) alternatives emerge, it will be difficult for Pandora to become profitable.

I don't think the comparison to Netflix is correct, however. Netflix is an interactive service whereas Pandora is a non-interactive radio service. Wouldn't you be willing to pay for an interactive service for your music, like Rhapsody or Grooveshark?

Pandora has both an ad-based option and a premium subscription service option for those who don't want to hear or see commercials. I think most of their customers will stick to the free ad-based version, and the more Pandora grows its listener base, the more it can charge advertisers. But unless they give listeners access to more valuable interactive subscription-based services, they are not going to experience huge profits.

Roger Goff said...

James, you make an excellent point. In fact, I think it clarifies the value issue. Netflix has value largely because of the ability to choose, where Pandora, without interactivity, feels like it should be free. (And obviously, music and movies are very different media in terms of the way they function in people's lives.)

In fact, I have subscribed to Rhapsody for years, so you're right in that assumption. But as you probably know, the royalty structure for an interactive service like Rhapsody is much higher than for "radio" services like Pandora. I think Pandora is trying to get as close as it can to interactivity without triggering the obligation for the higher royalty amount. Good idea, but I agree with you that it's still radio and subscription-based Internet radio is a tough sell.

Client Satisfaction Online Surveys said...

I'm not even going to argue whether the software works. I'm willing to assume that it does -- at least to some degree.