I usually receive some quite weird emails that are generally obvious scams. But the other day I received a very unusual one. It rang with a sincerity and genuineness that was quite compelling. It requested that I contact my government representative in order to save this company. It was signed by Internet wiz kid Tim Westergren, founder of online radio provider Pandora Media Inc. (Nasdaq: P).
Pandora builds personalized radio stations based on the "genetic code" of music one enjoys. The service utilizes the Music Genome Project as its musical-taste matching system. Built by music analysts and computer experts, the program is able to find songs similar to what the listener already likes.
The letter was asking for my support of a piece of legislation called the Internet Radio Fairness Act. By the tone of the letter, it really seems as if Pandora's survival hinges on this legislation passing into law. So all I needed to do was to click on the link at the bottom of the email to place my vote for the new rules.
I use Pandora's services on a daily basis and I believe it truly has a cutting-edge product, so I decided to take a closer look at the situation. In doing this, I found out just how much upside the stock could have if and when this legislation becomes law. And because the stock is down almost 50% since its IPO in June of last year, this is the perfect opportunity for investors to get the stock while it's still cheap.
Here's the story...
Pandora's has ultra-high content costs, having to pay more than 50% of its total revenue in royalties. This, in turn, smashes the company's bottom-line results, which is the main reason the stock has been cut in half since its IPO.
Because it's an online radio, Pandora has to pay royalties per song and not as a percentage of revenue like with other radio stations. For instance, Pandora pays about six times the amount satellite radio providers such as Sirius (Nasdaq: SIRI) pay to record companies as royalties.
This is where the Internet Radio Fairness Act comes in.
If the new bill passes, then Pandora would enjoy the same royalty standards as cable and satellite radio providers. As a result, Pandora's content costs will likely be slashed by 40-50% since royalties will be determined as a percentage of revenue and not per song. Of course, this will be a major boost for Pandora's bottom line -- and the stock price. The question is, as an investor, should you take the chance of the legislation passing into law?
Here's what the stock is telling us…
Shares gained almost 4% on the day the founder's letter hit users' email inboxes. So far this year, the stock is up 7%. In addition, the company has a growing number of followers, with 56.2 million active listeners and 156 million registered users, up 48% from the same time last year. So it's clear that things are looking good for Pandora and that the company just can't gain traction because of the draconian royalty laws.
Pandora is also facing stiff competition from other radio services like Spotify. But its Music Genome Project technology allows Pandora to create the most interesting playlists, which is definitely a huge edge over the competition. Not to mention, this unique way to create playlists is why the company has such a huge following. I'm still betting on Pandora to succeed.
Risks to Consider: Investing based on the outcome of legislative action is risky. But in this case, I believe there is a very strong chance the bill will pass into law. Most people see and understand the problems with the old way of assigning royalty payments.
Action to Take --> I love Pandora on a break out close above $11. I believe the legislation will eventually pass into law, granting a huge boost to Pandora's bottom line. I forecast shares to be above $18 once this legislation goes into effect, which is more than 60% upside from current levels. Remember, always use stops and position size correctly.