Satellite radio provider Sirius XM (NASDAQ:SIRI) is under intense pressure from the likes of Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN). This fact can be clearly seen in Sirius' latest second-quarter results, where the company's earnings declined year-over-year despite a rise in revenue.
Metrics are fine, but where's the earnings growth?
Sirius XM reported revenue of $1.04 billion, an increase of 10% from the year-ago quarter. However, its net income came in at $120 million, down from $125.5 million in the prior-year period. Sirius is making aggressive moves to protect its business from the onslaught of rivals with very deep pockets, and this seems to be working to some extent.
Sirius saw net subscriber additions of 475,000, which includes self-paying net additions of 380,000. This has increased its total subscriber base to 26.3 million and its self-pay subscriber base to 21.6 million. Now, Sirius is benefiting from increasing auto sales. The healthy annual run rate of auto sales, which increased 7% to 16.5 million, has certainly benefited the company's radio sales in new cars.
Looking ahead, the company is making efforts to sustain this rate of growth. Sirius is continuously working with OEMs on their long-term expansion plans. Currently, there are 65 million radio-enabled vehicles on the road, which means that Sirius has 27% of the market share. In the next five years, about 120 million radio-enabled vehicles are expected, which will grow to about 150 million in the next 10 years. Sirius expects that its 27% share will inch closer to its penetration rate of 70%.
Increasing royalty costs will hurt earnings performance
A look at Sirius XM's programming investments will reveal that the company's investment hasn't increased much over time. According to the 10-K, Sirius' programming costs went down from 2011 to 2012. From 2012 to 2013, it increased just 4%. Despite this cost control, Sirius has not been able to report earnings growth, as royalty payments have increased at a solid clip.
From 2011 to 2012, royalty and revenue share expenses increased 17%, and from 2012 to 2013, they increased 23%. In the previous quarter, royalty and revenue share expenses went up from $156 million to $200 million.
Looking ahead, this can increase at a faster clip, as Sirius is increasing content to ward off competition. The company recently announced that it will include "The Stephen A. Smith Show" on Sirius' Mad Dog Sports Radio. With this move, it will improve ESPN programming. In addition, Coldplay artist Chris Martin will also perform for Sirius XM's Artist Confidential Series. Moves such as these will lead to an increase in royalties, and continue to keep Sirius' bottom line under pressure.
Apple will throw a spanner into the works
However, looking at the moves its competitors are making, this seems like a far-fetched idea. Apple is increasingly improving its radio service. Apple recently acquired Swell, which specializes in podcasts. As reported by Wired:
"But the possible Swell deal-valued at $30 million-suggests Apple is approaching the space from all angles, targeting not just music, but podcasting as well. Swell lets users personalize their podcasts based on their interests and learns more about them based on the podcasts they skip or listen to."
Clearly, Apple is taking a more focused approach towards music now. In addition, the company is also adding popular channels to iTunes Radio. As reported by MacRumors:
"Apple has expanded the content available on iTunes Radio with a new ESPN Radio station and more than 40 local National Public Radio (NPR) stations. First noticed by AppleInsider, the new stations can be accessed directly within iTunes Radio on both iOS devices and desktop computers via a search, though the new stations may be available to some users in the Featured section."
Now, Apple will be able to leverage the strength of the increasing amount of content on its radio service by way of its CarPlay feature that was launched earlier this year. Apple CarPlay is the iOS platform for automobiles, and the company will deliver access to apps and other services through the platform. Since Apple is increasingly tying up with a number of auto companies, Sirius XM's growth might be in trouble.
As I had mentioned in my previous Sirius article:
"Apple is looking to revolutionize in-car infotainment with this venture. Ferrari, Mercedes-Benz and Volvo (OTCPK:VOLVY) have already started shipping CarPlay-enabled cars. Going forward, Apple is looking to bring Honda (NYSE:HMC), Hyundai (OTC:HYMLF), Jaguar, BMW (OTCPK:BAMXY), Chevrolet, Ford (NYSE:F), Kia (OTC:KIMTF), Land Rover, Mitsubishi (OTCPK:MMTOF), Nissan (OTCPK:NSANY), Peugeot-Citroën (OTCPK:PEUGY), Subaru, Suzuki (OTCPK:SZKMY), and Toyota (NYSE:TM) on board."
As such, since Apple is aggressively looking to deploy its CarPlay service at all major car makers going forward, Sirius will face some solid competition.
Pandora comes up with a new plan
Internet radio service provider Pandora (NYSE:P) recently announced that it has entered into a new deal with artists, marking its first direct licensing deal. Now, this move will enhance Pandora's content base, as artists will now have access to the company's data that will allow them to make certain strategic decisions. As reported by ABC News:
"That means Merlin-represented artists like Arcade Fire, Bad Religion and Lenny Kravitz could get more rotations as their representatives will be able to lobby Pandora to place their songs earlier in playlists where they fit.
Artists will also get access to Pandora data for the first time, enabling them to make informed decisions about where to tour, who to tour with, what their concert set list should be and what songs they might release next. They will also have tools to directly communicate with fans on Pandora.
For Pandora Media Inc., the move helps improve relations with artists, who have complained that royalties on digital streaming services are too low, especially as CD and digital download sales decline."
As a result, Pandora will now have access to more artists as it is making its platform more friendly. This will attract more users to Pandora's platform, and might force Sirius XM to make more investments to ward off the increased competition.
Why the bottom line will remain under pressure
Hence, Sirius XM will have to keep investing aggressively to sustain its growth rate or else it will fall behind the curve. Now, this will need investments. For example, Sirius is looking to widen the range and depth of its commercial free music programming by launching three new music channels in the categories of women, women's pop, country, and dance.
It has also introduced YouTube 15, which is a limited countdown to showcase the newest music videos emerging online. In June, it launched the TODAY Show Radio, which gives subscribers access to live audio feeds, including replays throughout the day. Sirius XM also penned an exclusive agreement with Joel Osteen, the spiritual and inspirational figure having millions of followers to promote the radio channel.
Weak fundamentals and balance sheet
But, as mentioned earlier, these will require investments. Sirius will have to spend more on content. Already, the company's balance sheet is strained due to a high debt figure and a weak cash position. Sirius has cash of less than $170 million, while its debt is way, way higher at $4.62 billion. At the same time, its current ratio is just 0.50, which means that Sirius is a fundamentally weak company.
Moreover, its bottom line has declined at the rate of 12% a year for the last five years, so it is clear that Sirius hasn't done well when there was little competition. It also has an expensive P/E ratio of almost 60. With the presence of bigger players in the fray, I think it will be wise for investors to stay away from Sirius XM, as the company might not be able to sustain its growth rate in the future.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.