It is said that when opening up Pandora’s Box what you find may seem very valuable, but it also may turn out to inflict a lot of pain and suffering in the long run. Today’s IPO market has gone from hot to sizzling with the recent debut of LinkedIn (LNKD). With an initial market cap around $3.5B, it quickly jumped to over $10B to now settle around $7.5B. That’s not half-bad for a company that earned all of $15M this past year.
Also soon to jump on the red hot IPO bandwagon is Zynga, Groupon and Pandora Media. Zynga’s IPO is expected to raise $500M, which puts the company’s valuation well over $10B. Groupon, who just a short time ago rejected a $6B offer from Google, is now hurrying its IPO that could give it a potential valuation of over $30B! At last check, the company lost $450M last year and is well on its way to topping that this year. Pandora Media which is also trying to launch its IPO and just filed an amended S-1 at the end of May. They are planning to raise over $100M with a valuation of around $1.3B. Not so quick Pandora as those closely reviewing their amended S-1 may see some reasons for caution. This article will take a deeper look problems lurking beneath the surface.
PandoraS-1A
First of all it is always interesting to see what the company’s use of proceeds will be. Most investors would naturally assume the funds will be used to further expand their business and expand their market share, but in Pandora’s case, investors should note that roughly 25% of the IPO proceeds will be used to pay unpaid dividends.
“We intend to use a portion of the net proceeds of this offering to pay accrued and unpaid dividends on our redeemable convertible preferred stock in connection with the automatic conversion of such redeemable convertible preferred stock into common stock upon the closing of this offering. The amount of such accrued dividends will be equal to (1) approximately $29.7 million.”
As was also noted in the amended S-1 filing, the remaining will be used for general corporate purposes and the company expects to continue losing money through at least 2012.
“As the volume of music we stream to listeners increases, our content acquisition expense will also increase, regardless of whether we are able to generate more revenue. In addition, we expect to invest heavily in our operations to support anticipated future growth and public company reporting and compliance obligations, as discussed more fully below. As a result of these factors, we expect to continue to incur operating losses on an annual basis through at least the end of fiscal 2012.”
More importantly, a deeper review of the amended filing yielded what some might consider a red flag with new disclosures about recently filed lawsuits. One in particular seemed to get the most attention being specifically identified, a recent patent infringement suit brought by Augme Technologies (AUGT). Some may recall Augme’s on-going battles with both American Online (AOL) and Yahoo (YHOO), where they have been going toe to toe, seeking to enforce their intellectual property rights. Notably over just the last six months, the company’s legal team has been bolstered by the addition of acclaimed patent attorney Don Stout to the company’s board, founder of NTP Holdings who in a hallmark case received a $612 million settlement with Research in Motion (RIMM) .
Additionally, the respected law firm of Goodwin Procter has joined the company’s efforts now handling all aspects of defending, licensing and monetizing their Intellectual Property. It was Goodwin Proctor leading the charge on behalf of Augme recently filing four additional suits against Pandora Media, Gannett, AOL and LucidMedia Networks. The last three were all filed in the Eastern District of Virgina, aka the “Rocket Docket.” The case against Pandora Media was filed in Delaware.
Let’s look at what Pandora Media’s recent filing states about their Intellectual Property.
“Our success depends upon our ability to protect our technologies and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including trade secrets, patents, copyrights and trademarks, as well as contractual restrictions. We enter into confidentiality and proprietary rights agreements with our employees, consultants and business partners, and we control access to and distribution of our proprietary information.
We have one issued patent and two patent applications pending in the United States. We do not intend to pursue patent coverage in additional countries at this time, but may in the future to the extent we believe such coverage is appropriate and cost effective.
Third parties have asserted, and may in the future assert, that we have infringed, misappropriated or otherwise violated their intellectual property rights, and as we face increasing competition, the possibility of intellectual property rights claims against us grows. For example, in April 2011, we were served with a complaint by Augme Technologies, Inc. alleging that we have infringed an Augme patent and seeking injunctive relief and monetary damages. Such litigation may involve patent holding companies or other adverse patent owners who have no relevant product revenue, and therefore our own issued and pending patents may provide little or no deterrence to these patent owners in bringing intellectual property rights claims against us. In addition, various federal and state laws and regulations govern the intellectual property rights associated with sound recordings and musical works. Existing laws and regulations are evolving and subject to different interpretations, and various federal and state legislative or regulatory bodies may expand current or enact new laws or regulations. We cannot assure you that we are not infringing or violating any third-party intellectual property rights.”
In April 2011, Augme. filed a complaint in the United States District Court for the District of Delaware against us alleging patent infringement. The complaint alleges that Pandora infringes an Augme patent and seeks injunctive relief and monetary damages. We have obtained an extension of time to respond to the complaint and are currently investigating Augme’s allegations. We currently believe that we have substantial and meritorious defenses to these claims and intend to vigorously defend our position.
The outcome of any litigation is inherently uncertain and there can be no assurance that the outcome of each case or the costs of litigation, regardless of outcome, will not have a material adverse effect on our business. In addition, the privacy lawsuits include allegations of violations of criminal statutes, and if we were found liable, there would be additional risk of criminal penalties.”
What does this tell us about Pandora Media and their own intellectual property portfolio? Short of one patent, it appears all but non-existent. It’s hard to imagine this one patent providing much in the way of barrier to entry, let alone protecting them if they are in fact infringing on other companies patented IP. This of course will be decided by the courts. Even in light of their already requesting an extension, it appears they only have until the 22nd of June to file a response.
Meanwhile and seemingly hurriedly, their IPO seems to be getting moved up fast. One has to wonder what the possible motivation for this could be; well maybe not considering the underwriters themselves just extended the company a $30M credit facility, $9M of which was drawn immediately.
“Underwriters for Pandora Media Inc.’s planned initial public offering have extended the online music service a $30 million credit facility” ~ according to the company’s new prospectus filed with regulators Thursday.
Affiliates of J.P. Morgan Securities and Morgan Stanley & Co. are lenders under the facility. Those firms are leading Pandora’s IPO alongside Citigroup Global Markets Inc.
The new facility replaces an earlier facility and equipment financing line that the Oakland, Calif.-based company received in 2009. The company said it drew down $9 million of the new facility on May 13, the day the company received it and retired the earlier loans.
Pandora, which sells advertising and subscriptions for its music streaming service, said it secured the new credit facility with its personal property, whichincludes accounts receivable but not intellectual property.
As the summer heats up, so has the IPO market. It remains hard to say whether these valuations are excessive or just the launching point. Many want to compare this to the internet bubble from years ago, but keep in mind it took years for that bubble to form and actually burst. This is still very early in the game for a lot of these companies. One thought I always have when looking at these companies is what if Google had not paid $1.6B for YouTube and it went public right now? I have to think its valuation would rival those like we’re seeing with Groupon or even the much heralded Facebook.
While I have little doubt many of these companies will be hugely successful in their field of expertise, I always believe it important to keep an eye on Intellectual Property, competitors and potential barriers to entry. Pandora’s competitors are also well known with the likes of Apple’s iTunes, Google (GOOG), CBS Radio or Sirius (SIRI). Of course Augme was one of the original internet radio companies and owned BoomBox Radio which was where the Augme Intellectual Property was first used.
Any way you slice it, IP is going to play a huge role in the future evolution of these companies and others, those that have it will have a significant leg up and staying power far beyond those who don’t. When I look at a company like Pandora Media, and I see that by their own admission not only do they have little of it, but they are already disclosing what appears to be a major material liability regarding the challenging of foundational technology at the very core of their business.
One must ask themselves, what if they lose their ability to use it just how much of that projected $1.4 Billion valuation hinges on their ability to continue to use? Whatever happens, read those filings closely, at least in the case of Pandora Media, you can’t say they we didn’t warn you.
In closing, Marshall Phelps who is a world renowned IP expert formerly with IBM and Microsoft, had the following to say:
‘You can’t license patents if you don’t own any,’ he says. ‘In a networked world where everyone’s technology must work together, patents have become the reigning currency.’
I’m a long time investor with investment experience in high tech, biotechs and precious metals. I blog on topics that are of interest to me and my goal is to generate intelligent discussion. I don’t consider myself an expert in any one area, but know a little about a lot of things. I believe as soon as we stop learning, we stop living.
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