Pandora Value Trick in Double-Premium IPO (P, SIRI, LNKD)

Pandora Media, Inc. (NYSE: P) was already getting a premium price after the underwriters lifted the price range once.  Word had been out that another premium was coming after the range went from $7 to $9 up to $10 to $12.  Rather than the $14 we had heard as an indication yesterday morning and rather than the $15 hat CNBC had reported Tuesday afternoon, the Pandora IPO priced at $16.00 per share.

The customized internet radio outfit, home of the Music Genome, sold some 14.7 million shares, with 6.0 million being sold by the company and about 8.7 million shares being sold by selling stockholders.  The original share count to be sold was also listed as 13.7 million shares and the original market cap was being put around $1.3 billion.

Pandora is often referred to by investors as the SIRIUS XM Radio Inc. (NASDAQ: SIRI) of the internet, but its models are almost opposite for now.  Until Pandora’s mobile players are installed at a rate that the SIRIUS XM radios are installed in new cars, the models are opposite.

The sale of the shares will be roughly $235 million, but the company’s market cap is close to $2.6 billion.  Pandora is trying to play almost the same game that LinkedIn Corporation (NASDAQ: LNKD) played when it came public.  This is another hat-trick IPO where the company is only registering a tiny portion of its float.  Our stance is that this artificially drives up the price and valuation because the float is so small that it creates a premium.

The fact that the price effectively went up twice and that insiders are more than half of the offering is a flag as well.  Pandora is not expected to be profitable any time soon and the bulk of its revenues are advertising rather than subscriptions.  It also has a problem in that the more music it plays the higher the royalties are that it must pay musicians and their labels.

This last year Pandora generated $137.8 million as far as revenues, but about 90% was ad-generated revenue.  Only about $18.4 million of its sales came from subscription services.  We have no expectations that Pandora will be profitable at any point in the next year as its operating and royalty costs will likely rise just as fast as it can raise revenues.

The book-runners are Morgan Stanley and J.P. Morgan; the co-lead manager is Citigroup, and the remaining co-managers are William Blair, Stifel Nicolaus Weisel, and Wells Fargo Securities. Pandora has also granted these underwriters a 30-day overallotment option to purchase up to 2.2 million additional shares.  Pandora will not receive any proceeds from the sale of shares by the selling stockholders.

Our take is not that there is something not-cool about Pandora.  Actually, the reason for the excess demand is because Pandora actually has a service that is attractive to listeners.  That is what drove the interest.  Our problem is that this is twice what it was originally indicated at, the float is too small, and insiders are generating more cash from this IPO than the company is.  There will be a huge float-overhang out in the future when lock-up expirations come.

With a double-premium, we won’t be shocked at all when and if the deal opens even higher than the $16 share price.  Still, we do not like to see this sort of pre-IPO action.  It has all of the action that the deal is richer and richer and skewed in favor of Pandora’s selling stockholders more than in favor of the company and more than in favor of whoever subscribed to the IPO.

JON C. OGG