Pandora (P) Shares Tumble on Convertible Debt Offering

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Shares of Pandora Media, Inc.P fell over 5% yesterday in the aftermarket session following the company's announcement of a senior note offering.

The company will be offering $300 million aggregate principal amount of convertible senior notes due 2020. Morgan Stanley & Co. LLC, acting as the sole book runner for the offering, will be granted a 30 day option to purchase another $45 million worth of notes.

Pandora expects to use some of net proceeds to compensate the "capped call transactions" costs and the remaining for general corporate purposes.

Of late, Pandora has fallen out of investors' favor. Shares of Pandora have tanked over 31.1% since October. Pandora, which is primarily popular for its Internet radio service, has been struggling as a result of the increasing popularity of on-demand streaming music. The company had been seeing a slowdown in its subscriber base owing to the aggressive marketing strategy of Apple Music (especially three-month free trial plan) and competition from other players like Spotify and Amazon AMZN Music. What is even more concerning is that even after the end of the free trial period, Apple managed to amass a decent number of paid subscribers.

Pandora is overhauling its offering to provide all of "radio, on-demand and live music" on its own platform. As a part of this effort, the company acquired streaming music service provider, Rdio for $75 million. Given that buying Rdio as a going concern would have been a far more expensive process, the company intends to acquire only "technology and intellectual property" from Rdio, after its filing for Chapter 11 protection.

Rdio, founded in 2010, is a popular streaming music service with operations in over 100 countries. However, in the past couple of years, the increasing popularity of Spotify and Apple Music took a toll on Rdio's subscriber base. The company that was once valued at $500 million (in 2013) has now filed for bankruptcy in order to save itself from the accumulated debt. The acquisition will be contingent on Rdio obtaining approval from the bankruptcy court.

While Rdio has not been able to sustain its growth, Pandora is betting on its technology and geographical reach. In contrast to Rdio's availability in 100 countries, Pandora is operational in only 3 so far.

Pandora investors are probably wary of the risk involved (though natural) as the company tries to redefine itself as a multi-product, multi country service provider. While the cost of this acquisition is small compared to Pandora's cash and investments level of $363.6 million at September-end, it seems that the company has taken too much on its plate at once.

Add to it, the pending $450 million acquisition of ticket provider Ticketfly and things appear more worrisome. Pandora announced Ticketfly acquisition in October. The combination of Pandora and Ticketfly will allow the duo to harness user generated data to tell fans when bands or artists they enjoy are in town and sell tickets to them while also steering artists to areas where large amount of people gave them a "thumbs up" on Pandora's platform.

The deal could be a big positive for both companies, as it comes at a time where music streaming is increasingly popular, and when touring is becoming a larger source of income for artists. The main business of Ticketfly, and the main source of interest of Pandora, is events at smaller venues with independent artists because that's where many concert tickets are sold.

However, considering the risks involved in pursuing so many new products at once and also the tedious task of integrating the two strategic acquisitions, investors can't be blamed for being jittery.

Moreover, Pandora reported dismal results in the third quarter of 2015. Not only was the company's reported loss much higher due to a one-time royalty settlement, but revenues also failed to meet expectations. Furthermore, investors were disappointed as Pandora lowered its revenue guidance for 2015.

The company's content acquisition costs escalated significantly in the quarter as it had to shell out $90 million in a settlement with record companies for pre-1972 recordings. Pandora now expects revenues for 2015 in the range of $1.153 billion to $1.158 billion, lower than the earlier projection of $1.175 billion to $1.185 billion.

Moreover, the impending verdict in the ongoing litigation surrounding royalty rates remains an overhang. In September, the company received a favorable opinion on the case and a few days back the Register of Copyrights delivered her "Memorandum Opinion in response to a novel material question of law referred to her on Sep 11, 2015 by the Copyright Royalty Board (CRB)".

It is the "second round of questioning referred to the Register of Copyrights by the CRB in the "Webcasting IV" rate setting proceeding, which will determine rates for the period of 2016-2020".

The trial part of the proceedings concluded on Jul 21 and the verdict is likely to be out by Dec 16, 2015. Pandora signed a deal with Merlin in Aug 2014 and decided to settle royalty rates directly with Merlin instead of paying U.S. government's compulsory rates. It argued vehemently that the rates so decided were reasonable and should be considered as a benchmark. However, SoundExchange, a non-profit organization that collects royalties and provides it to artists was not in favor of setting the Merlin deal as a benchmark.

Last year alone, the company paid 66% of its total revenue in royalties. In addition, stiff competition from Spotify, iHeartRadio, and Apple Inc.'s AAPL Apple Music are making things tough for Pandora. Therefore, if the royalties are less, it will have more money to reinvest in its business and drive profitability.

It can't be denied that there are too many headwinds currently that threaten Pandora's prospects in the near term. However, we believe that if the company is able to successfully implement its overhauling strategy; it can position itself well to gain from the increasing demand for music streaming, thus improving monetization and driving strong mobile growth.

Currently, Pandora has a Zacks Rank #3 (Hold). A better-ranked stock is MeetMe MEET , which sports a Zacks Rank #1 (Strong Buy).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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