The music industry is one that I find quite intriguing, based simply on the fact that is has been transformed so heavily by the evolution of the internet. If there is one industry that I would avoid investing in at all costs, the music industry would be it. Yet here comes Pandora, the darling child of internet radio with an IPO. The market seems to think it’s worth $1.68 billion. I once again am skeptical of this valuation. What else is new right?

For those of you who do not know what Pandora is, it’s an internet radio and streaming service. It’s unique because it doesn’t allow you to choose and play a specific song, but rather plays a stream of music based how you rate songs that you hear. It is essentially a combination of internet radio and music streaming. It uses a “freemium” model whereby users are able to use the service for free (which is ad-supported) and then can pay a monthly fee to gain access to additional features and ad-free content. I actually used to use this service in Canada a few years back until Pandora got hung up on licensing and became United States exclusive. At that time there was not a huge selection of music available. That brings me to the issue of licensing.

Sites like Pandora or at the mercy of the various record companies they hold licensing agreements with. These record companies are seeing declining revenues and increasing piracy worldwide. They hold all the power in this relationship and can pretty easily ruin the business of a company like Pandora if they yank a licensing agreement. Pandora is so dependent on their ability to license music that there are huge amounts of risk involved in the companies business model (think NetFlix). Pandora is just one of many companies in the space that can experience severe hurt if record companies decide to get tough and ask for money.

Pandora is not alone in this space. They are not the only company that offers music on the internet. They are competing with the likes of Spotify (coming to market), Grooveshark, Napster, iTunes, and countless others. All companies have different business models but operate on a similar premise. Let’s not forget the other ways to get music today: rip it off sites that allow you to stream, Youtube, Torrents and Peer to Peer Downloads, internet radio, and direct from the artist’s website. I’m sure I’m forgetting countless others, but that’s a good start. The point is, Pandora by no means has a choke-hold on the music industry. The music industry is a sinking ship. Long gone are the days where you had to buy a CD for $20 to get new music that had just come up. Boy were we fools for buying CD’s.

Pandora’s growth is also limited. It’s hard to understand such a huge valuation when very little is clear on where the majority of their growth will come from. They can’t expect to get much bigger in the US. In Europe, there are already well established competitors like Spotify. When I was in Sweden, everyone and their grandma was using Spotify. I just don’t see where the growth in this company is going to come from, other than incremental fee increases to premium subscribers. Someone please enlighten me.

My view on Pandora is that while it is a viable business, I believe it is overvalued. It definitely could be considered what I think is a potential (although very slight chance) tech bubble.

Thanks for reading!

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