Music Fans Are Ditching Pandora For Spotify, Apple iTunes: Rich Tullo

Rich Tullo of Albert Fried downgraded Pandora Media Inc P to Underweight from Overweight on lower-than-expected quarterly earnings and outlook. Further, the company’s 3-tier strategy could drive users to competitors such as iTunes and Spotify.

Revenue in the third quarter was $351.9 million missed Tullo’s $361.8 million estimate, which itself was about $5 million below consensus. Further, high costs and lower revenue resulted in “shockingly bad” operating margin of -$119 million versus Tullo’s -$40 million estimate.

Related Link: Pandora Tumbles On Meager Results

“Thus quarter in our view was bad beyond what an investor should expect from the original guidance. Pandora in our view had a huge opportunity and we think they lost focus and slashed their own virtuous cycle wheel,” Tullo wrote in a note.

In addition, the analyst disliked Pandora’s 3 Tier product structure with lower margins at the higher subscription tiers. Pandora expects operating margin of 25 percent for Pandora Radio, 15 percent for Pandora Plus, and it is 10 percent for the yet to be rolled out Pandora Premium.

The company is planning to fetch more margin dollars from Pandora premium given much higher ARPU. Users prefer more free services over premium subscription.; However, according to Tullo, Pandora is shifting from a viable business strategy.

“We think 3 Tier is an upside-down business model when combined with a weakening US economy. Thus we made an error in upgrading Pandora. Far better in our view is to upgrade Pandora Plus users, use a Netflix style model and price it at $6 to $7 a month with all the features of Pandora Premium,” Tullo highlighted.

Meanwhile, Tullo noted that Pandora is no longer a takeover target due to its negative guidance, negative FCF, and complex business model.

In fact, the analyst blamed the company for burning cash, taking risks with its subscriber base and not focusing on growing the user base of Pandora Radio. All these will now drive users from Pandora to iTunes or Spotify.

“We think Pandora last night opened a proverbial box of worms,” Tullo added.

Shares of Pandora closed Tuesday down 4.84 percent to $12.18. In the pre-market hours, the stock lost another 9.28 percent to $11.05. The analyst cut the target price by 50 percent to $8.