Following on the successful recent IPO of LinkedIn, online music service saw its stock price jump after IPO shares were first introduced at about $16 per share. The stock saw an early run that pushed it as high as 48% above the IPO price, but those gains quickly evaporated as investors became wary of the company's business model and some of the limitations that seem to be structurally inherent in the way Pandora serves its customers.
One of the primary concerns for Pandora is that its costs increase as it acquires new listeners and as existing listeners listen to more music. And while some minor uptick in costs would be expected, Pandora's costs are tied to increased licensing fees that it must pay to record labels as it serves more music. This model essentially ensures that Pandora's earnings will always be limited and that the lion's share of the company's revenue will be passed through to the major record labels.
Pandora makes the vast majority of its money from advertising and the company has never been profitable in over ten years of existence. And while those are not sure signs of a flawed business model, they are certainly red flags that must be vetted.
In the case of Pandora, its valuation seems to be hugely out of line with the company's potential for long-term success. Its estimated market cap of $2.8 billion is about 20 times the company's 2010 sales. To put that into perspective, Amazon.com's market cap is calculated at only 3 times the company's 2010 sales. By most estimates, Pandora is probably going to struggle to perform from an earnings standpoint. Perhaps there is more to the story that is yet to emerge - maybe the company is positioned to be bought by one of the established players? Or perhaps this is just how investment banks make easy money after a recent real estate bubble and global financial crisis have forced them to change their focus.
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