Pandora Shares Plummet on Sour Fourth-Quarter Forecast
Pandora Shares Plummet on Sour Fourth-Quarter Forecast

Pandora Media (NYSE:P) shares had dropped 5 percent in midday trading Monday in the wake of music-streaming service Spotify's unveiling of upgraded radio features. The broader market was also down Monday, meaning Spotify wasn't behind the entire decline. By 2 p.m. ET the S&P 500 was down 2.1 percent and the Nasdaq composite was down 1.8 percent. But Pandora dropped 5.1 percent on Friday as well.

Knee-jerk reactions like this clearly reveal the nature of investors' thinking about Pandora. Investors are not as scared of Spotify as they are fearful that Pandora doesn't have the ability to stave off competitors. Indeed, the barriers to entry in Internet radio are quite low. A company can use statutory licenses to stream music at a known, set royalty without the need for upfront payments to rights holders. This is Pandora's model and it will have many copycats. And on-demand services with negotiated licenses (who have paid big upfront fees) also have the tools to create Pandora-like radio features. While subscription services are more hands-on than Pandora, they are quickly creating features that offer a more "lean back" listening experience.

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But stock swings like we're seeing now are unnecessary. An investor holding shares for the long term (which is not always the case, of course) should value Pandora under one of two scenarios: either the company has established enough of a leadership position to justify a high valuation or it does not have a sustainable competitive advantage and merits a lower valuation. There just isn't much reason to sit in the middle. If you can see clearly into the years ahead, why react only to what is right in front of you?

Although it is an innovator and market leader, there is no doubt Pandora will face constant competitive threats. More music services like Spotify will improve their radio features. More Internet radio companies will try to capture the same radio market share Pandora is seeking. A bearish investor need not wait for those threats to emerge. Instead, the inevitability of threats in the future should dictate current valuations.

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Pandora is down 33.2 percent in the last month. On Monday it reached an all-time low of $9.15 (the company went public in mid-June). As long as investors react to every little piece of potentially damaging information, and until Pandora can ease investors' concerns about its vulnerability to threats, expect more stock swings like we're seeing now.