Why Pandora Is Likely To Be Valued Under $3 Billion If Sirius XM Acquires It

It has been the third time within last twelve months that the rumors about SiriusXM (NASDAQ:SIRI) taking over Pandora (NYSE:P) have surfaced. According to an article by CNBC, the sources close to the company have told that Pandora is considering a buyout opportunity after investment firm KKR made a commitment to invest $150 million dollars in the company during Q1’17.

Here Are The Key Highlights To Consider if Sirius XM were to acquire Pandora:

1. Sirius XM Wants On-Demand Music, Pandora Wants Cash!
2. Pandora Premium – The Only Hope Left To Become Profitable
3. Best Case Scenario – Pandora Values At $12/per share

See Our Complete Analysis For SiriusXM

What’s In It For Both The Companies In This Potential Acquisition?

Sirius XM has a new competitor in the form of Apple CarPlay and Android Auto which are offering both on-demand and streaming services. SiriusXM has done quite well with the satellite radio streaming part; however, it needs to strengthen its on-demand music services in comparison to Apple Music, Spotify, and Pandora. Acquiring Pandora will give it the leverage of exploiting this feature, especially when Pandora has recently launched its on-demand service, Pandora Premium, with a backing of 76 million active users behind it.

On the other hand, Pandora has been losing cash faster than ever before. Its free cash flows stood at -263 million for 2016, and its cash and equivalents were just over $200 million by the end of Q1’17. Although KKR has made a commitment to invest $150 million in the company, at this rate, Pandora is only left with the cash fuel for just over a year. An acquisition by Sirius XM will provide a relief at this end.  (Also See : What Lies In The Box For Pandora If It Agrees To Be Acquired By Sirius XM)

Will Pandora Premium Be Able To Rescue?

Pandora Premium was launched during the end of Q1’17 at a subscription price of $10 per month. The initial response to this service was positive as it managed to receive 500 thousand trials in just over a month of its launch. The reviews about Premium have been encouraging as the users are rating its playlist features and ease-of-use better than that of Apple and Spotify. With Premium, Pandora is aiming to increase its paid subscribers from the current 4.5 million to anything between 6 million to 9 million by the end of this year. That amounts to about $20 million to $50 million extra revenues per month or up to half a billion dollars of annual revenue expansion. This is one of the key reasons why CEO Tim Westergren intends to achieve profitability by the end of this year. Pandora’s net loss has increased from $16 million in 2012 to $343 million in 2016.

Pandora’s Valuation: $3 Billion At Best?

Despite an impressive top-line growth, Pandora’s bottom-line has not performed in a way which can delight the investors. So, putting a value to a loss making company with negative cash flows is a highly speculative task. However, Pandora’s situation in terms of its Free Cash Flow to revenue ratio is similar to what its nearest listed peer, Sirius XM, was facing in 2009. SiriusXM’s FCF/revenue in FY’09 was -12%, which has grown on to reach 19% by the end of FY’16. Pandora’s FCF/revenue currently sits at -19%.

Now, let’s assume the scenario where Pandora is able to achieve its target of becoming profitable by the end of FY’17, and it’s FCF/revenue ratio follows the trajectory similar to what SiriusXM achieved historically: reaching 19% by the end of 2023. Then, Pandora’s valuation comes out to be around $3 billion, that is, $12 per share (We have calculated Pandora’s WACC at 10% and assumed FCF to grow at 2.5% eternally after 2023).

This may be the best case scenario for Pandora as we have not considered the fact that Pandora Premium is likely to face a tough battle from Apple Music and Spotify, and if it fails to convert its free listeners to paid ones, then the actual valuation can be a lot lower than $12 per share.  On the other hand, Sirius XM did not have any fierce competitor at that time and did not offer any free services to its registered users.

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