Monetization of the music digital space has been slow and is yet to provide consolation for the dearth of revenue in the industry. But the transition from physical to digital product may finally begin to gain some traction. June 15th, 2011, marked the Initial Public Offering (IPO) of streaming radio service, Pandora
(NYSE: P). Ahead of the IPO, the company found itself valued at $4.2 billion. This was more than three times the current market value of the Warner Music Group. While the comparison stretched the imagination, it suggested much promise for Pandora and the industry.
A Chequered History
Tim Westergren and his partner Will Glaser founded the company in 2000. Despite a rapidly expanding user base and growing brand recognition, since the beginning Pandora was on the verge of bankruptcy. In its first four years, it survived on Westergren’s eleven credit cards, black jack winnings from Reno, and a $1.5m angel investment. In 2004, at his 348th pitch to investors (sic), Westergren finally procured $9 million from Larry Marcus, a venture capitalist at Walden Venture Capital. The investment was used to reimburse employees for two years of unpaid wages and then set the wheels in motion for a better future. “The pitch that [Tim] gave wasn’t that interesting,” Mr. Marcus said, “but what was [attractive] was Tim himself; we could tell he was an entrepreneur who wasn’t going to fail.”
In 2007, the company nearly went down on the news that the Federal Royalty Board had raised the fee that Internet broadcasters had to pay to record labels for the use of each song aired. “Overnight our business was broken,” Westergren said. “We contemplated pulling the plug.” But with characteristic vigor, he hired a lobbyist in Washington to fight the new law. Lawmakers settled after two years at a lower rate, which kept the company above water.
Pandora released an iPhone app in 2008, which brought in over 35,000 new users per day— driving it towards its first and only year of profitability by 2009, collecting about $50 million in revenue mostly from ads. Since that time, and with innovations like the voice-activated synch system currently being installed in Ford and Mercedes automobiles, Pandora has grown. With the recent stock offering, the company will likely have enough resources, including capital, to take ownership of the Internet radio market.
The IPO and Market Volatility
On June 15th, 14.7 million shares of Pandora stock hit the New York Stock Exchange (NYSE) at $16 per unit. They quickly rose by 51% to a peak of $24.20, and then, by 10:41 AM, fell back to $20.71. By 1 PM, the stock dropped to $18.55 and by 4:30 PM, when the NYSE closed, it settled at $17.45— an 8.88% increase from the opening bid. In the event, Pandora was valued at over $2.8 billion, not nearly as high as the pre-sale estimate of $4. 2 billion, but more than twenty times its sales’ revenue in 2010.
In the two weeks following the IPO, the stock has seen considerable fluctuation in its value. As of June 30th, $24.20 remained the high point, but the low dipped to $12.16— 24% below the original asking price. These abrupt shifts have become periodical since the stock hit the market.
Rapid changes like these can be attributed to a number of factors.
First, Internet-based companies have been experiencing more movement on the NYSE in the first two quarters of 2011 than they have since the ‘dot com’ boom of the late nineties— most notably with Pandora, Russian search engine Yandex NV, and professional social networking site LinkedIn, which provided first day gains of more than 55% on May 19th of this year. This second ‘dot com’ boom has created lots of excitement. “There’s pent-up demand for high-growth, [and new ] business models,” says Scott Billeadeau, who helps oversee $18 billion at Fifth Third Asset Management in Minneapolis.
Another potential cause of these fluctuations could be the general lack of understanding that investors —and the public in general— have of the digital music space. In a recent Billboard Magazine article, Glenn Peoples explained that numerous financial articles covering Pandora’s IPO, including one from the Wall Street Journal, have made inaccurate assumptions about Pandora’s service, its competition, and its income sources. One prevalent inaccuracy is that if and when Spotify does make its U.S. debut, Pandora , as well as other radio services like, Sirius XM, could lose market share. But Pandora and Spotify are actually two completely different services that deliver on two very different platforms and needs. Furthermore, regardless of how Spotify’s $10 monthly price point affects Pandora’s $3.99 per month charge, subscription revenues only account for 15% of Pandora’s total (the other 85% comes from ads) This would make Pandora’s market position stronger and its stock prices less volatile.
The limited number of shares that were initially offered by the company may also explain the instability in Pandora’s stocks. Similar to LinkedIn’s IPO last May, Pandora offered up less than 10% of the total company to the public. Joe Kennedy, Pandora’s CEO, maintained that “the size of the offering [reflected] the capital that the company wanted to raise and the reality that our largest shareholders [weren’t] interested in selling”. Analysts like Francis Gaskins, president of industry tracker IPODesktop.com, have noted that “surging demand for new Internet companies, combined with a dearth of available shares, may give the businesses higher valuations than they deserve”—and therefore lead to significant price corrections.
Despite the overall success of Pandora’s IPO, the company is still far from stable. It must be remembered that after over a decade of existence, annual losses were the norm. In fact, collections on opening day amounted to $234.9m and were not enough redress the expected drain on Pandora’s finances through 2012. On the plus side, Pandora’s user base continues to grow every day. As of April 30th, the number of active accounts had risen to 94m from 82m in January and climbs at a rate of one new signee per second. This, above all, is what makes Pandora an exciting proposition for investors.
By Evan Kramer