It’s the 'Apple Effect' Stupid! Not the Fiscal Cliff

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of internet radio giant Pandora (NYSE: P) are being killed, down almost 20%. This is following what I would consider by the company to have been an exceptional earnings report – relative to expectations. But this is not why the stock is getting hammered.

Instead, the punishment was the result of statements made by the company’s CEO, Joe Kennedy as he issued fourth quarter guidance. Kennedy suggests that the company’s outlook, which is lower than abysmal will be the result of the “fiscal cliff.” Really? His statements shocked investors who were already fragile by the company's real threat, which has nothing to do with monetary policy.

Let’s Call It What It Really Is

It seems everyone expects that congress will come to a resolution before the deadline – except Kennedy and all of Pandora’s advertisers. I don’t buy it. The true reason for Pandora’s dismal outlook has less to do with the “fiscal cliff” and everything to do with Apple (NASDAQ: AAPL). But why pass up a good “get out of jail free” card. The fiscal cliff has become a doorknob. But it’s now getting old.

Here’s the good news, there is nothing about Pandora’s current fundamentals that suggests that the company can operate successfully for several more years. Even though there have been concerns about profitability, the company doesn’t nearly get enough credit for coming as far as it has in a market dominated by satellite radio’s Sirius XM and iTunes.

What’s more, there are new entrants such as and Spotify that are beginning to threaten Pandora’s internet dominance. Yet, despite these competitive pressures, the company remains the standard among a group that is rapidly growing in abundance.

On the other hand, these challenges didn’t matter as much. At least not until several weeks ago when rumors surfaced that Apple was planning a streaming radio service of its own. Investors panicked – sending Pandora’s stock down almost 20%.

But then shares started to rebound slightly when cooler heads prevailed. Investors realized that they overreacted. The focus instead turned to the company’s upcoming earnings report, which it announced on Tuesday after the market closed. Although expectations were low, Pandora surprised the street with better than expected Q3 results.

For the period ending in October, Pandora’s net profits more than tripled to $2 million – helped by a combination of growing revenues and sound cost management. Excluding stock-based compensation, adjusted earnings arrived at $0.05 per share – beating street estimates by $0.04 cents.

Likewise, revenues rose 60% to $120 million – also beating street expectations. So essentially, it seems the company is operating on all cylinders - this is despite an already tough advertising environment. So how is it possible that all of a sudden in the next three months management can expect such a drastic reversal?

Essentially, Pandora is saying it will go from beating the street’s profit estimates by 4 cents per share in one quarter and then the very next quarter it expects to report a loss as high as 9 cents – whereas analysts were expecting a 1 cent profit. It doesn’t make sense. In other words, in a three month period the company will go from +4 to -8. Even in golf that would be impossible.

Instead, let’s call it what it really is, Apple plans to enter the market and take it over. We also can’t entirely rule out the possibility that advertisers are avoiding making long terms commitments to Pandora as they wait to learn what Apple has to offer.

It makes perfect sense. After all, with Apple’s popularity, it stands to reason that companies are more likely to get a better bang for their advertising dollars. It’s also possible that advertisers are now in a much better negotiating position with Pandora, which can potentially hurt the company long term leverage.

Although Apple has yet to confirm its entrance into the business, it makes too much sense for the company not to. What’s more, that Microsoft (NASDAQ: MSFT) also plans to launch a rival service will only add increased pressure on Pandora to find a new landing spot as an acquisition candidate.

Bottom Line

As I’ve said recently, Google (NASDAQ: GOOG) will make the best partner. If for no other reason than to get under the craw of it most hated rivals in Apple and Facebook (NASDAQ: FB) - especially the latter, which it continues to fight for advertising dollars. But also, we can't ignore that Google should make this deal to avoid Facebook from jumping in first.

So if Kennedy wants to blame the fiscal cliff for Pandora’s anticipated Q4 struggles, that’s fine. In that regard I hope congress is listening and now feel increasingly more motivated to get a deal done. But I know better. For that matter, so does Apple.

rsaintvilus is long AAPL and has no positions in the other stocks mentioned above. The Motley Fool owns shares of Apple, Facebook, Google, and Microsoft and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Apple, Facebook, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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