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Must-know: Why the shorts had Pandora wrong

Part 2
Must-know: Why the shorts had Pandora wrong (Part 2 of 6)

Expecting competition from Apple, Pandora’s shorts piled on

Revenue growth fails to impress

Shortly after Pandora’s June 2011 $16-per-share IPO, the stock sank and began to languish between $7 and $12 per share for several months. Investors expressed concern over the long-term prospects for the Internet streaming radio upstart. In particular, doubts emerged about the company’s ability to fend off competition and manage growing content costs. After experiencing tremendous revenue growth of nearly 700% in just a few years, the sustainability of such a trajectory came into question. Pandora is a member of the Global X Social Media Index ETF (SOCL), which seeks to provide exposure to an index of social media stocks.

Pandora_short vs long (part 2)_short interestEnlarge Graph

The short case

The core thesis for the bear case on Pandora is simple: low barriers to entry and better-positioned players would give rise to increasing competitive threats. Initially after the IPO, Spotify launched a U.S.-based music streaming service that was driven by social recommendations from peers and achieved rapid acceptance from users. Other similar services such as Songza and iHeartRadio, owned by Clear Channel, quickly followed suit.

By summer of 2012, Pandora had achieved a 90% share of online streaming music minutes, according to Comscore. Yet the stock remained nearly 40% below the IPO price. Looming over the company was news that Apple and Google were developing music streaming services as well. Apple in particular represented the greatest threat, as the company already had a large established user base from iPhone and other iDevice customers, knowledge of its customers’ habits, its own algorithm for predicting music choices named Genius, and years-long relationships with major music production companies since the advent of iTunes and the iPod.

Given Apple’s scale, relationships, and marketing power, this threat was certainly the most ominous. The result, displayed in the chart above, was a massive rush to short the shares of Pandora, with many expecting an eventual outright failure of the company. At peak, investors were short nearly one-quarter of the company’s share outstanding. The selling pressure eventually pushed the stock down to single digits. While the expectation of rising competition appeared to be playing out, bearish investors raised additional concerns regarding Pandora’s business model, a topic we’ll address in the next part of this series.

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