One of the perils of being a successful company is that you begin to attract quite a bit of attention. Sirius XM (SIRI), which has dominated the premium radio market over the past couple of years - reaching almost 25 million subscribers, is no exception. Apple (AAPL) wants some of this success. The question, though, is what does this mean for Sirius XM investors when Apple enters the market. If you noticed, I didn't say "if."
The Apple Effect to Sirius and Pandora
Apple's entry into the realm of music streaming is not news and has been rumored for some time. However, what is noteworthy here is the possible date of the announcement. We feel it will come in June at Apple's annual Worldwide Developers Conference (WWDC). For that matter so does Katy Huberty, analyst at Morgan Stanley. According to AppleInsider, Huberty said:
"Apple could make a surprise announcement at the upcoming Worldwide Developers Conference in June regarding a new type of internet service such as streaming music or a mobile payment system. She went on to say that Apple Internet Software and Service chief Eddy Cue is believed to be working to improve existing services like iCloud and Maps, but at the same time is planning to launch new initiatives."
As dominant as Sirius XM has been over the past couple of years, investors also understand that Apple does not play for second place. While Sirius has fought off rivals such as Pandora (P) and Spotify, Apple is a bigger fish to fry. Here's what Apple sees here; Sirius XM's total subscribers increased 9% year over. As impressive as this is for any paid subscription service, Apple is more impressed with the company's free cash flow growth, which surged 846% year over year.
However, Sirius is not alone in this performance. Pandora's fourth-quarter results also included 54% growth in revenue, which prompted some Pandora bulls to proclaim that Apple should buy Pandora instead. While Pandora's growth is outperforming Sirius, Pandora's ability to generate cash is not as attractive to Apple. The advertising model is not a platform that Apple, which values the user experience, wants to be in.
Besides, the advertising model has shown to be too unpredictable and extremely volatile. What's more, Pandora's business, by virtue of its own recent statements regarding music royalty fees, is on shaky ground. If you recall, from its own website, Pandora had to "sang the blues" - announcing that it was installing a 40-hour monthly limit on anyone listening for free listening via a mobile device. This is even though the company said that of its active listeners, less than 4% will feel this effect.
Apple should make a bid for Sirius
Nevertheless, the growth of both Sirius and Pandora has enticed Apple. Companies don't often enter markets if they don't believe there's profit potential. Apple is about cash production. And unlike Pandora, Sirius is raking in tons of it. Plus Apple knows from its own growth in iTunes, which grew market share by 63%, that music lovers still have an insatiable appetite for their audio. But here again, unlike both Pandora and iTunes, Sirius, by virtue of its premium offering is the standard.
To that end, Apple should make a bid for Sirius. Consider this; Apple, which has just raised its dividend by 15% as well as its stock buyback by $50 billion, is now seen as more shareholder-friendly, according to David Einhorn. The Street has rewarded the company with $80 worth of gains since the stock reached bottom at $385, or almost 20%. However, Apple does not want to touch its $145 billion cash to fund its "generosity."
The company has instead opted to issue cheap debt. But this is a temporary solution, and nor does it address the fact that Apple needs more growth. Although 11% revenue growth is solid for a company of Apple's size, it's not what Apple is used to. This is where Sirius XM, which has 20 million self-paying subscribers, which grew 9% year over year, can help Apple rake in the cash to fund future buybacks.
The $10 billion value proposition
Given that Sirius has almost 25 million subscribers, of which 20 million are self-paying, Apple is looking at a potential goldmine. First, Apple will want to differentiate itself from Pandora. Given all of the copyrights-related litigation that Apple has tossed at Samsung, Apple will want to look and feel different. That said, investors would be pleased with some "Pandora-like" features. This is a term that is often thrown around that Apple wants to stay away from.
However, unlike Pandora, Apple can use Sirius' strong subscriber numbers to monetize the platform. Apple wants to up-sell. Sirius already has 20 million people that have demonstrated they are willing to pay. Plus, Apple now has access to Sirius' affluent demographic that will be exposed to more Apple products. Besides, Apple is already accused of "pandering to the rich."
Apple will be able to introduce this new audience to music that they would otherwise not have been exposed to. Along with a "buy now" feature to give them the option to keep the song, Apple would immediately make money. Sirius, which generates $12.05 revenue per subscriber, and posted revenue of $897 billion in the quarter, can turn into $5 billion business for Apple within its first year.
Given what Apple has been able to do for iTunes, Sirius revenue growth under Apple can possibly double to $10 billion by the second year. Remember, Apple just reported $43.6 billion in revenue in its fiscal second-quarter. However, and more importantly, Sirius furthers Apple's strength to dominate the automobile dashboard, where Siri, Apple's voice navigation assistant, is already gaining traction.
I like Sirius' long-term prospects. But in my opinion, so does Apple. Otherwise, Apple would not endeavor to enter the automobile dashboard where Sirius has been the dominant force for years. What's more, with reasons such as Sirius' strong subscriber growth and its premium offering, Apple has to announce its radio ambitions with authority. Today, there is not a brand that is more authoritative in the premium radio market than Sirius.
Given Sirius' current market cap of $21.5 billion and trading at $3.40 per share, an offer of $4.50 might close the deal. But would Sirius investors accept? Plus, Apple would have to get the approval of Liberty Media (LMCA), Sirius XM's majority shareholder. I think Liberty would take it. So would I.