Pandora IPO: No Profits, but There's Always Hope

Last Updated Jun 15, 2011 4:29 PM EDT

Pandora Media, the radio website, is worth $2.6 billion if you believe that the $16 price that its stock (P) commanded in its initial public offering fairly reflects Pandora's value. (You must think it's worth more if you were one of the buyers who paid as much as $26 after trading began Wednesday morning, before the stock fell back to close at $17.42.) It's tough to see it that way using any objective standard, but with no letup yet for Internet Mania 2.0, the phenomenon that has carried LinkedIn (LNKD) and others to the stock market in recent weeks at exorbitant valuations, fair has nothing to do with it.

Pandora customizes radio content to give its 90 million listeners what it thinks each of them wants to hear based on expressed preferences and established habits. (Some have observed that whatever criteria listeners plug in, the list of songs that Pandora selects closely matches what's on their iPods.)

The site is very popular. Revenues, which Pandora generates from ad sales and from subscriptions to a premium service, are growing strongly. They totaled $137.8 million in the financial year ended Jan. 31, according to the regulatory filing for the IPO, compared with $55.2 million the year before.

The problem for the company and its brand-new shareholders is that its losses are growing, too, and there is little evidence that the trend will reverse or that Pandora will make a profit -- it has never done so -- any time soon. Pandora lost $1.8 million in the year through January. That was barely 10 percent of the loss for the previous year, but the loss ballooned to $6.8 million for the quarter that ended in April.

One reason to be skeptical of Pandora's ability to earn money is a shortcoming endemic in the media distribution business. As listeners and revenues increase, so does the amount that must be paid for content. The regulatory filing spells out what Pandora is up against:

"Since our inception in 2000, we have incurred significant net operating losses and as of April 30, 2011, we had an accumulated deficit of $92.1 million. A key element of our strategy is to increase the number of listeners and listener hours to increase our market penetration. However, as our number of listener hours increases, the royalties we pay for content acquisition also increase. We have not in the past generated, and may not in the future generate, sufficient revenue from the sale of advertising and subscriptions to offset such royalty expenses. If we cannot successfully earn revenue at a rate that exceeds the operational costs associated with increased listener hours, we may not be able to achieve or sustain profitability. In addition, we expect to invest heavily in our operations to support anticipated future growth and public company reporting and compliance obligations. As a result of these factors, we expect to continue to incur operating losses on an annual basis through at least fiscal 2012."
Another obstacle to profitability is the existence of numerous competitors plying their trade in the burgeoning fields of Internet radio and digital music, including Google (GOOG), Apple (AAPL) and CBS, the corporate parent of MoneyWatch.

In the Greek myth, Pandora's curiosity got the better of her and she opened the box containing all the evils of the world, releasing them forever. All that remained was hope. Investors in the namesake radio site must have plenty of that if they buy a stock with such a rich valuation and a payoff that's so far away, if it comes at all.

On CNET: Pandora Shares Jump in Initial Trading
On ZDNET: Pandora Debuts, Public Venture Capital Returns
Pandora Jukebox Collects a Lot of Coin for Some Investors
Pandora's Cost of Music Isn't the IPO Problem Critics Think