If a just-announced definitive agreement between Sirius XM (NASDAQ:SIRI) and Pandora (NYSE:P) goes as planned, Sirius will own Pandora by early next year -- a move that would form the world's largest audio entertainment company.

The $3.5 billion deal has Pandora stock rising and Sirius stock falling on Monday. As investors digest the implications of the deal, here's an overview of the transaction and a look at what it means. 

A woman wearing wireless headphones is holding a smartphone.

Image source: Getty Images.

The deal

Announced early Monday morning, Sirius XM's acquisition of Pandora would build on Sirius' current 15% stake in the company. To own the remaining shares of Pandora, Sirius has agreed to offer a fixed exchange ratio of 1.44 newly issued Sirius shares for each outstanding Pandora share.

"Based on the 30-day volume-weighted average price of $7.04 per share of SiriusXM common stock, the implied price of Pandora common stock is $10.14 per share," Sirius explained in a press release about the deal, "representing a premium of 13.8% over a 30-day volume-weighted average price."

The transaction values Pandora at $3.5 billion.

Importantly, the merger agreement gives Pandora a "go-shop" period in which the company can actively consider deals with other parties. This means that if other companies are interested in acquiring Pandora, they still have a chance to enter into negotiations and make a better offer.

Why merge?

The deal will create a number of synergies, Sirius and Pandora management believe.

First off, the combined company would create the world's largest audio entertainment company. Sirius boasts over 36 million subscribers in North America and more than 23 million users on an annual trial. Meanwhile, Pandora has over 70 million monthly active users and about 6 million paid subscribers. 

In a press release on Monday, Sirius CEO Jim Meyer explained the reasoning for the deal:

The addition of Pandora diversifies SiriusXM's revenue streams with the U.S.'s largest ad-supported audio offering, broadens our technical capabilities, and represents an exciting next step in our efforts to expand our reach out of the car even further. Through targeted investments, we see significant opportunities to drive innovation that will accelerate growth beyond what would be available to the separate companies, and does so in a way that also benefits consumers, artists, and the broader content communities.

More specifically, Pandora should benefit from Sirius' greater financial resources and in-car presence, while Sirius can tap into Pandora's mobile, digital, and advertising strengths.

While the combined company plans to cross-sell its services and create new audio packages that utilize both companies' strengths, Sirius said it plans to keep operating both companies' brands and services.

Of course, the likely main reason for the acquisition is to form a company that can hold up against rising competition from Apple, Spotify, and Amazon as the three companies invest aggressively in their music services.

Pandora investors priced in some of the anticipated premium on Monday, with shares trading 7.9% higher at $9.81 as of 9:38 a.m. EDT. But there appears to be less enthusiasm about the deal from Sirius XM investors, as shares are trading about 2.5% lower as of 9:39 a.m. EDT.

Subject to shareholder votes, regulatory approval, and other customary closing conditions, the deal is expected to close during the first quarter of next year, Sirius said.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.