Sirius XM Should Buy Pandora Media

Sirius XM can reduce potential competitive headwinds by buying Pandora

Jun 13, 2014 at 9:30AM

Sirius XM(NASDAQ:SIRI) has been growing its subscriber base and subscription revenues, and has started to look for newer avenues for revenue growth, as evidenced by its acquisition of the connected vehicles unit of Agero.

The company has a fantastic position with more than 25.8 million subscribers, but its Internet offerings are not all that popular due to its car-centric service. However, Sirius XM might change that by acquiring Internet radio company Pandora Media (NYSE:P). Consumers are increasingly utilizing music streaming services, compared to buying or downloading music, and, as a result, ad-supported business models like Pandora are thriving.

Pandora is growing 
Pandora continues to grow its subscribers and revenues, but its net income remains in the red and has been a little volatile in the past. The leading Internet streaming service is doing surprisingly well, in spite of newer competition from Apple (NASDAQ:AAPL) which has more 20 million listeners, still well below Pandora's 77 million listeners as of May 2014. Pandora controls 31% of the U.S. music streaming market, according to Edison Research.

In addition, Pandora has roughly 3.5 million paying subscribers, and its monthly listening hours increased 28% year over year to 1.73 billion hours in May 2014. Pandora also has a very strong footing on mobile devices, as mobile revenue accounted for 76% of Pandora's total sales in Q1 2014. Pandora was profitable in the holiday quarter, but swung to a loss in the last quarter as the company's out-sized content acquisition costs continue to be a major issue. 

Sirius XM already has great relationships with content providers, and if a large company like Sirius XM can work with Pandora's team to negotiate for lower music royalty payments, the company could turn profitable. It's also worth noting that Pandora has more than 250 million registered users, and integrating Pandora into some car-infotainment systems will enable Sirius XM to grow advertising revenue. In addition, Pandora is devising innovative advertising products like Promoted Stations, which will help marketers drive consumers to customized content as well. 

Pandora also has a growing paid-subscription business as well. In Q1 2013, Pandora's subscription revenues made up 16% of its total revenues, while in the last quarter subscription revenues made up 27% of Pandora's revenues. 

Similar businesses and synergies
Apple hasn't been able to make a serious dent in Pandora's business, and Pandora is doing very well -- at least on a usage basis. But Apple's decision to acquire Beats for $3 billion to ramp up its music streaming offerings might mean it will seek to become more competitive in the space in the future. 

So it makes a lot of sense for Pandora and Sirius XM to be under the same roof, and yet operate as separate brands providing different services to consumers. Sirius XM can substantially increase its advertising revenues by taking market share from ad-supported terrestrial radio by owning Pandora Media, and also have a great offering on the Internet and mobile devices.

And Sirius XM can continue to feature commercial-free music on its platform and have a wide array of exclusive content in more than 140 channels to keep its 25.8 million subscribers happy. And Pandora's growing subscription revenue plays right into Sirius XM's core competency. Sirius XM's original content, produced by its own studios, can also be made available on Pandora's platform -- in the process generating incremental revenue for Pandora from non-music sources. 

Sirius has the financial muscle
The satellite radio company has the adequate financial resources to buy a company the size of Pandora. Sirius XM's stable cash flow and EBITDA growth characteristics will enable it to borrow a lot more cash and apply more leverage in its capital structure. At the end of last quarter, Sirius XM had total debt of $2.9 billion, but raised another $1.5 billion in the current quarter to maintain its leveraged business model in the low interest rate environment. Sirius can raise more cash and stock for a possible merger with Pandora. 

Sirius XM could also be opportunistic in acquiring Pandora, as the leading Internet radio service saw its stock price experience a dramatic pullback during the broader technology sector sell-off. 

Combining two franchises dominant in their own respective categories would be a great move. And with Pandora's valuation being a lot more reasonable than it has been in the past, an offer from Sirius XM would be opportunistic and strategic at the same time. 

The bottom line
Sirius is the dominant company in the satellite-enabled car entertainment space, and has growing fundamentals. The company could bolster its Internet offerings by acquiring Pandora, while also eliminating a competitor as Pandora is increasingly being added to dashboards in numerous cars. To put it simply, Sirius XM buying Pandora would be a great move.

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Ishfaque Faruk owns shares of Sirius XM Radio. The Motley Fool recommends Apple and Pandora Media. The Motley Fool owns shares of Apple, Pandora Media, and Sirius XM Radio. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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