Morgan Stanley Changes Its Tune On Pandora, Downgrades To Equal-Weight

Morgan Stanley is changing their tune on the embattled streaming service Pandora Media Inc P.

As Spotify gears up to skip an IPO and go straight to market, Pandora’s influence continues to dwindle despite a growing market.

The Analyst 

Morgan Stanley analyst Benjamin Swinburne lowered his rating from Overweight to Equal-Weight and lowered Pandora's price target from $12 to $6.

The Thesis

Amid a growing music streaming industry, increasing advertising revenue in 2018 is no longer a given for Pandora, as the company faces engagement and monetization challenges, Swinburne said. (See the analyst's track record here.) 

Healthy advertisement growth is critical for any company in the streaming space due to the constant uncertainty and battle with rising music licensing costs.

“We thought Pandora could potentially reach 10-percent advertising growth in ’18 … However, we now expect 2017 to show a nearly 15-percent decline in listening hours, an over 5-percent decline in ad-supported monthly active users and slower growth in advertising ARPU,” Swinburne said.

Declining advertising metrics have a substantial impact on expectations for share price appreciation for two reasons, according to the analyst.

“First, it meaningfully reduces the company’s ability to drive any operating leverage in the business due to both rising licensing costs and a fairly large fixed cost base relative to its gross profit, and to required product developments and sales and marketing needs. Second, the higher estimated FCF burn potentially could bring Pandora back to the capital markets to deal with refinancing a 2020 convertible bond, despite its recent preferred equity investment from Sirius.”

Pandora’s core free product has not changed much over the years, meaning it's being threatened by competitors Spotify, Apple Inc AAPL and Amazon.com, Inc. AMZN, as well as the proliferation of free on-demand music from YouTube.

While Pandora is trying to improve engagement through a more interactive model, Swinburne said the most meaningful growth could come from non-musical content such as podcasts.

Price Action

Pandora shares were down nearly 7 percent late in Monday's trading session at $4.82. 

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