Pandora More Unsustainable, Overvalued Than Netflix

By David Gould - September 12, 2012 | Tickers: AAPL, NFLX, P, SIRI | 0 Comments

• Email
• Print

You've heard about "Everybody Loves Raymond." How about "Everybody Hates Netflix" (NASDAQ: NFLX). From ticked consumers to angry investors, the sentiment surrounding the "premier" media business has transitioned from positive and upbeat to bearish and downright resentful. What fascinates me about the Netflix story is how the market can just make such a roundabout view on a stock - in one second, it viewed the business as bulletproof; in the next, it viewed the business as unsustainable. Like a feather breaking the camel's back, the catalyst for this change was a seemingly minor hike in prices.

In the process of raising prices, Netflix, has, however, achieved one thing: recognition for its online streaming line. The company argues that this is the main path forward for the business, but it has become clear that content rights are highly expensive and becoming increasingly expensive. Moreover, the business model ends where a Google search begins (read: piracy is easy). International growth appears to be a main driver of value, but this may come at the cost of margins that support near-term liquidity.

Despite all of the negative headwinds, Netflix still manages to trade at a respective 31.1x and 60.3x past and forward earnings. Even forecasted growth does not justify the current valuation. The firm has grown earnings by 42.5% annually over the past 5 years and is expected to grow by "just" 18.1% over the next 5. With the PEG ratio at 1.72, it will need to grow at a faster rate to justify the current stock price, and I do not believe that this risk is worth taking for the reward. Analysts seem to agree with my sentiment and rate shares closer to a "sell" than a "buy."

However, the sentiment is decidedly more bullish at Pandora (NYSE: P), where analysts rate shares closer to a "buy" than a "sell." In my view, however, Pandora is even more overvalued than Netflix. It has little operating history but still negative double-digit ROA, ROE, and ROI. It is valued at more than 18x book value and does not have the kind of marketability as Netflix. Music is easily accessible through market leaders, like Sirius XM (NASDAQ: SIRI) and Apple (NASDAQ: AAPL). While Pandora's attractive make-your-own-station feature is certainly attractive, I do not believe that it provides a sustainable edge over competitors. That is to say, Netflix is arguably more sustainable… and here's why:

Despite being very irritated at the price hike, I still use Netflix about on a weekly basis. Although movie selections can easily be found online, pirate websites are often too sketchy for many users. Replete with pop ups that go from one site to the next, viruses appear to be lurking in every corner. By contrast, when you go to Netflix.com, you arrive at a clean website… well, sort of. 

Netflix.com recently had a web design that I feel overly strains my control. There used to be "friend" features, like a social network, lists, and an active reviewer program. That has since been replaced with a down-to-business layout that has various box covers with a play button in front of them (disclosure: I just use the Instant Watch option now). It just appears that the site is getting a little desperate. But, all in all, I know I am not going to get any viruses when I go to the website (although there has been outages not widely reported by the investment community.)

Pandora, on the other hand, can't sustain itself through a site or radio. Music goes through many different mediums, and it is easier to find reliable ones that is to find reliable substitutes for Netflix. Put differently, Netflix has a more sustainable business model than Pandora. I thus say hold off from Netflix and short Pandora.

• Email
• Print
• Feedback