Pandora Media Stock Upgraded: What You Need to Know

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

One day after an acquisition announcement helped push Pandora Media (NYSE: P) stock up nearly 3%, shares of the digital audio streamer are rising again this morning. Pandora shares are up nearly 6% in pre-market trading on news that analysts at Raymond James have raised their rating on the stock two notches to strong buy and assigned an $8 price target.

But does this upgrade make sense? Here's what you need to know.

Pandora goes shopping

Let's begin with the news that sparked Pandora's stock rally yesterday. On Wednesday, Pandora announced that it has agreed to acquire privately held, San Mateo, California-based AdsWizz, which Pandora calls "the global leader in digital audio ad technology." Pandora's goal is to "upgrade Pandora's ad tech capabilities, provide its advertisers with greater audience reach, and expand the company's revenue opportunities." It hopes to finalize the acquisition in Q2 2018.

Citing data from the Interactive Advertising Bureau (IAB), Pandora says advertising on digital audio platforms is growing at a 42% rate, and that it wants to "capitalize on this trend" to "create the largest digital audio advertising ecosystem." Because AdsWizz is a privately held company, however, it's not clear how well Pandora's new subsidiary is capitalizing on this growth, or if it's doing so profitably.

Pandora itself provided no information on AdsWizz's sales or profits, saying only that the acquisition of the 10-year old company "does not change the first quarter 2018 guidance or the full year 2018 commentary that was provided on Pandora’s most recent earnings call."

What does it mean to Pandora?

That's not too surprising, because AdsWizz is a much smaller operation than Pandora itself, suggesting little ability to immediately move the needle at the new parent company. AdsWizz's asking price $145 million, payable in cash and stock, is just over 1/10th Pandora's own market capitalization of $1.25 billion.

Despite the disparity in sizes, however, Raymond James argues today that by acquiring AdsWizz, Pandora will grow its addressable market to $28 billion and "materially" expand its reach in digital audio advertising, as explained by Raymond James goes so far as to argue that AdsWizz could be worth $4 per share.

Does this make sense?

Currently, Pandora stock sells for just a few cents less than $5 a share. Raymond James' new $8 target price, when multiplied by Pandora's 255 million shares outstanding, implies that in spending $145 million to buy AdsWizz, Pandora has effectively added $765 million to its own market value.

Put another way, Raymond James is asserting that AdsWizz itself was probably worth $765 million (to Pandora at least) -- and that in paying a measly $145 million for it, Pandora managed to buy the company on sale for 80% off.

On its face, that seems a pretty extreme statement. If AdsWizz were worth so much more than Pandora is paying, any number of other digital audio players -- SiriusXM, for example, or Spotify -- could have swooped in and bought it just as easily, or at least initiated a bidding war that would force Pandora to pay more to buy its new prize. The fact they did not bid for AdsWizz logically suggests that none of them thought the company was worth even the $145 million that Pandora has agreed to pay for it.

The upshot for investors

On its face, Raymond James' argument for AdsWizz turning Pandora from a hold into a strong buy makes no sense. Pandora has never earned a profit without AdsWizz (Pandora actually lost more than $500 million last year, according to data from S&P Global Market Intelligence). With AdsWizz, Pandora by its own admission says it will see no improvement in its "full year 2018" earnings.

If you ask me, this acquisition is simply not a good reason to upgrade Pandora stock.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Pandora Media. The Motley Fool has a disclosure policy.