Why It’s Time To Bail on Pandora and Buy Sirius XM

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

Earlier this week, I called out Joe Kennedy, the CEO of Pandora (NYSE: P) for making comments that I thought were “less than genuine.” Kennedy said that the fiscal cliff would be the reason for Pandora’s expected Q4 struggles, when in actuality astute investors knew better.  It had everything to do with Apple (NASDAQ: AAPL), which is rumored to be entering the music streaming business.

Upon issuing the poor guidance, shares of the stock got hammered. Kennedy’s statements ruined what was an otherwise excellent earnings report. Investors want to know if Pandora can survive should Apple enter its market. I’d like to be optimistic, but I just don’t see how it can. But first, here’s the good news.

Can Pandora’s Business Model Last?

Pandora continues to improve in areas where critics say it can’t – profitability. From that standpoint, the company more than tripled its net income – reaching $2 million during the quarter. Likewise, gross margins improved by 1.5 points while the company saw a 136% improvement in EBITDA.

So in fairness, as I’m being critical of Kennedy, I have to credit the company for managing expenses and growing revenues, all of which led to a much improved bottom line. But on the other hand, it won’t be enough to give investors the patience needed to allow Pandora the time to figure out what Apple’s next move is going to be. But it gets worse.

As Pandora is working to improve its competitive position, the company has to deal with rising content and royalty costs. Although this is nothing new for Pandora, it is still an area where the company has consistently underperformed. And these royalties are getting more costly per song while growing each year.

With this situation being entirely out of Pandora's control, at some point the company will have to convince the street that its business model can overcome this. But there is no clear solution. For this reason, I think this put Sirius XM (NASDAQ: SIRI) in a position to capitalize on Pandora’s failure. But will Sirius seize the opportunity?

Since after all, Pandora’s 7% share of the radio market will have to go somewhere and Sirius seems as a likely landing spot. But then again, it all hinges on what Apple has planned. It’s worth noting however that Apple has yet to confirm its entrance into the business.

Moving forward

Nonetheless, this has not stopped rumors that Apple has secretly met with record labels in deal negotiations. And frankly I would be surprised if something does not happen sometime in the first quarter of next year. It makes too much sense for Apple of avoid this opportunity.

If nothing else, Apple can use its iTunes advantage and make its music and movies exclusive only to Apple devices. While that may force customers to choose Apple over Android and Windows based products, I worry that Apple may hurt its iTunes business with such a restriction. On the other hand, it might be worth considering if Apple is able to offset this by increased market share in high-end hardware such as iPads and iPhones.

The big loser will be Pandora while Apple and Sirius gain market share. Sirius in particular, stands to gain from two events. Aside from an inevitable Pandora death, Sirius also benefits from its content-sharing agreement with Google, which now has a interesting decision to make.

Google (NASDAQ: GOOG) must now decide if it wants to acquire Pandora just to aggravate Apple or does the company see Pandora’s revenue growth as an attractive asset that it absolutely can’t do without. Also the advertising potential that Pandora can provide Google can't be ignored. This is in a addition to being another neat streaming tool that goes along well with YouTube.

Bottom Line

With so many possibilities amid so much speculation, who at this point would want to open “Padora’s box?” Sorry, I couldn’t pass that one up. But suffice it to say, the company has a lot to think about – this is on top of guidance that scared the daylight out of weak investors.

Even more remarkable is that the fiscal cliff might get resolved before the deadline. So I’m curious to see if Pandora issues an immediate revision to it numbers if it happens. But I'm not holding my breath. Even it the company did, it would not be enough to avert the threat of Apple. For now, I’m staying away from the stock.


rsaintvilus has a long position in Apple. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple and Google. 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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