12/15/2017 Value Investors Club / Pandora Media Inc (P)

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Pandora Media Inc P

October 30, 2017 - 6:44pm EST by u0422811 (/member/u0422811/47644)
2017 2018
Price: 7.23 EPS -0.54 -0.08
Shares Out. (in M): 243 P/E N/A N/A
Market Cap (in $M): 1,759 P/FCF N/A N/A
Net Debt (in $M): 143 EBIT 0 0
TEV ($): 1,901 TEV/EBIT N/A N/A

Description
I think Pandora is a compelling long. I will pause here to let that sink in and I realize half the VIC community will get squeamish just thinking about a tech name down (hopefully the
other half is excited about a tech name down so much in one of the most epic tech bull markets). Yes I think a stock that is down 43% YTD and has a 39% short interest is compelling.
But before I get into the meat of the pitch let me set the tone:

I don't know where I'm goin

but I sure know where I've been
hanging on the promises in songs of yesterday.
An' I've made up my mind, I ain't wasting no more time
but here I go again, here I go again.

Tho' I keep searching for an answer

I never seem to find what I'm looking for.
Oh Lord, I pray you give me strength to carry on
'cos I know what it means to walk along the lonely street (x-apple-data-detectors://1) of dreams.

Here I go again on my own goin' down the only road I've ever known.
Like a drifter I was born to walk alone.
An' I've made up my mind, I ain't wasting no more time.

I think the great bards David Coverdale and Bernie Marsden really nailed it with this one. It perfectly summarizes the Pandora pitch. On the off chance anyone needs more I
guess I can explain more below.

Pandora is a high tension tech stock that has had multiple historical missteps. Pandora has had years of mismanagement and now with Liberty backing (via Sirius) has a
highly favorable risk/reward skew. Liberty owns ~16% of Pandora via a convertible preferred stock that converts 25% out of the money. The upside in Pandora is driven by
three main factors:
1. Growth in listener hours driven by stabilizing user numbers and increasing hours per user that will be generated as streaming uptake accelerates
2. Higher RPMs generated by a combina on of higher ad load and effec ve use of higher value ad formats and programma c adver sing
3. Cost ra onaliza on driven by a solid management team under Liberty Media’s close watch

Pandora has 76M ac ve users in the US, of which, 71M of them listen to Pandora’s “lean-back” ad-supported product at over 23 hours per month on average. Pandora has been
poorly mismanaged and has undergone three CEO changes in the past two year. Some lowlights:
1. Buying Ticke ly for $400M and then selling it 18 months later for $230M.
2. Spending $150M to create an on-demand service to compete with Spo fy & Apple despite both having a mul -year lead
3. Neglec ng its core ad business to first try and compete with Apple/Spo fy and then because they wanted to pivot and become a label themselves
4. Proac vely capping ad-load for now ra onal reason
5. Building two “Taj-Mahal” like HQs and hiring an insane amount of people – i.e. one of the more awe inspiring collec ons of “corporate fat”

A er this ill-fated entry into on-demand streaming Pandora fired its old management team and BoD, received a capital injec on from SIRI, and re-focused on its core adver sing
product. Pandora announced their new CEO on August 14th. Roger Lynch has a good background and was the former CEO of Sling Media. He has a strong tech background, knows
how to run both an ad supported and subscrip on business, and most importantly knows how to run a lean ship. He has already made some good hires for the ad-tech group.

To butcher a quote – great ar sts steal. We have definitely heard this song from the Liberty playbook before. In Jan 2009 Sirius was near bankruptcy and Liberty outbid DISH to put
$530M in Sirius via conver ble preferred. They did this in two tranches ($280M and a follow on tranche later). Within a quarter of Liberty inves ng Sirius was able to get to FCF
posi ve and from there it was a rocket ship. Pandora is oddly similar – it’s the exact same instrument (conver ble preferred with a ered investment – they accelerated the 2nd er
faster than anyone an cipated which is normally not a bad sign). As previously men oned Liberty also replaced the CEO and the BoD. While I can’t be sure – this does feel like I am
listening to Robin Thicke (x-apple-data-detectors://3)’s song “Blurred Lines” which we all know was just li ed from Marvin Gaye (x-apple-data-detectors://4)’s :Got to Give it Up” -
net-net we have heard this song before, and it worked really great the last me.

Management changes and Liberty don’t ma er unless users stay around as that is the core of Pandora’s value. People are concerned that users are star ng to churn off. What they
are missing is that Pandora’s core value is the Mom & Pops (x-apple-data-detectors://5) out there that will never change. Out of their 71M lean-back US listeners there is a core
cohort that will con nue to use Pandora for years to come irrespec ve of ad-load. If it isn’t broke don’t fix it! People mistakenly think this competes with Apple and Spo fy and it
does not. It is an en rely different use case. The cohorts that uses this isn’t looking to create playlists or listen to cu ng edge stuff – they just want lean-back streaming radio to play
music for them for long periods of me. There is also something to be said about connected car and how that is just taking off now (wasn’t easy for Mom & Pop Main Street to use
prior to the latest few models of cars) and there is a massive untapped poten al in spoken word which Pandora is now ge ng into with podcasts, etc. (genome project will be
expanded at the podcast level – which in my own humble opinion as a podcast consumer is pre y cool).

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12/15/2017 Value Investors Club / Pandora Media Inc (P)
Pandora has a near-monopoly on the online local audio ad market which is ~$15B. And right now their ad-load is 1/6 (x-apple-data-detectors://6)th (x-apple-data-detectors://6) that of
terrestrial radio. They can easily increase ad-load to 8 to 9 30 second spots up from ~5 today (terrestrial radio is at ~15 min per hour or 30 ad spots) – and if they do that this thing is
a home run. Pandora will be able to both increase ad-load and increase CPMs as they can be er target customers than terrestrial radio can. As Pandora further shi s its ad mix
from na onal down to local it will naturally increase their RPM (aka Pandora will naturally make more money!). The prior management team also proac vely capped ad-load, so just
bringing it up to where it naturally should be let alone ever trying to compete with terrestrial (which it won’t get to that level) results in drama c financial results.

Addi onally we are witnessing a big change in audio ads via the introduc on of programma c audio. Unlike the programma c introduc on to display, audio will not experience CPM
defla on as there is limited ad space (you can always make another blog on the internet with ad space, but we only have two ears and can listen to one song at a me). The added
kicker to this is programma c audio will make Pandora drama cally more efficient in delivering ads. Right now 8-10 people touch every ad served on Pandora (each sales person has
3 assistants helping them). This number should be closer to 3-5. So Pandora can actually cut their SG&A by something like 25% just ge ng their headcount numbers in line with
industry averages. Once they fully embrace programma c this number can go even lower. In speaking with former employees they universally said that Pandora was a bloated and
inefficient sales team – and it’s not like the results have hidden this fact.

So you have a new team (CEO and BoD), a product people have loved for years but has go en muddied due to mismanagement, a cost base that is about to drama cally cut, and a
revenue stream that is about to massively inflect. Seems like a good set up. You take all these together and I get to something like $1 in FCF by 2020. While I am not sure what
mul ple it deservers I have a feeling Mr. Market won’t be valuing this business at 7x FCF.

Further – I also think you have limited downside risk as Pandora is trading close to liquida on value. You can break Pandora up into three component pieces:
1. The NOL – Sirius’s NOL will be used up soon and John Malone doesn’t exactly love paying taxes so he is on the NOL prowl. Luckily Pandora has a nice fact NOL and even
using Sec on 382 limita ons we can take the NPV of this to find some value.
2. The subscrip on business – not much has been said on this, but Pandora has recently raised prices on this – they are clearly no longer running this as a charity opera on and
instead intend to run it for profit. I assume they just run it for cash and take a CLV based valua on approach based on an elevated churn.
3. AD business – I assume 30% of users walk overnight and the other piece they push ad-load up to a staging 1/3 of terrestrial radio ad load.

You take all these and sum them and cash and ne out debt and compounded PIK on the preferred and get to something like $6.70 per share. Given that this thing is trading at $7.20
now. I will take $0.50 of downside for probably $7+ of upside any day.

If management even and Liberty media are even marginally competent this is one of the most favorable risk/rewards I have seen in a while. The stock has been hit extra hard lately
due to a large shareholder liquida ng their posi on – I suspect this was a forced liquida on due to redemp ons making the opportunity that much more interes ng. To paraphrase
the great band Ra this one is dangerous but worth the risk.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst
This quarter will mark the first earnings call for the new CEO. As revenue starts to inflect from higher ad-load / CPMs, and cost cutting begins the
financials will massively inflect. Further there is also a free option on an eventual SIRI merger which is in the cards as SIRI's NOLs expire and Pandora
inflects given SIRI's convertible preferred stake.

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Messages
Subject Questions
Entry 10/30/2017 10:52 PM
Member techval699
Thanks for the write-up. I wanted to understand your perspective on their subscription businesss?  Why do you say that Pandora has raised their prices recently? I have not seen them
announce that but I could have missed it.

Can you describe the economics of their subscription businesss? If you listen to Liberty and Sirius management talk about their investment in Pandora, they are clearly focused on getting
Pandora to pivot back to the ad-supported business. Hence, what do you think the new management team does with the subscription business?

Also, do you have a view on how the company can get back to generating positive FCF and how they get to $1/sh of FCF?

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