“With the 1st pick of the 2011 NFL Draft, the Carolina Panthers select Cam Newton, Quarterback from Auburn University” these were the words uttered by NFL Commissioner, Roger Goodell as he announced the start of the NFL Season. While the draft took place earlier this week, it required a U.S. District Judge to order an immediate end to the league lockout; siding with the players in their bitter fight with the owners over how to divide $9 billion. Even with the ruling, the fate of the 2011 NFL season remains in limbo and rests in the legal process.
As I watched the rest of the first round, I was reminded of another pending dispute that involves Sirius XM (SIRI) as seeks to defend itself from the anti-trust case scheduled for trial on Monday, May 2nd.
Investors will be wondering what the implications may be as Sirius is also due to report earnings only one day later (5/3). Last month, I discussed why I feel this case is a non-event and with Sirius having announced that it will report earnings one day after the trial is set to begin, it gives me further cause to believe that they don't anticipate any adverse reaction to the case.
To understand why I continue to feel that this suit is nothing more than a nuisance, I want to remind you of four important points made by the Department of Justice and the FCC back in 2008.
At the onset of the merger, which was granted approval, the Department of Justice's Antitrust Division was quoted as saying:
- "After thorough and careful review it's determined that allowing the two satellite radio companies to merge is not likely to harm consumers."
- "The merger could actually benefit consumers, who might see lower prices as the result of more efficient operations, broader programming options, and faster rollouts of new technology."
- "The Division reached this conclusion because the evidence did not show that the merger would enable the parties to profitably increase prices to satellite radio customers."
- "The competitive alternative services available to consumers; technological change that is expected to make those alternatives increasingly attractive over time; and efficiencies likely to flow from the transaction that could benefit consumers."
To win government approval for the $4.9 billion deal, Sirius and XM successfully convinced the Federal Communications Commission to waive a key regulation and persuade the Justice Department that any price increases would be constrained by a competition from free, over-the-air radio and new technologies.
What prompted this anti-trust case was several 2009 complaints by Sirius subscribers who claimed that Sirius abused its monopoly power by illegally raising prices by almost 30 percent. The suit points to the music royalty fees that Sirius charges in addition to the fees it charges subscribers.
Carl Blessing filed the lawsuit on behalf of himself and other Sirius subscribers. It seeks unspecified damages, which may be tripled under antitrust law. In the ruling, the judge certified a class of Sirius XM customers who, since July 29, 2008, paid the music royalty fee, an increased monthly charge to activate more than one radio, or an Internet access fee.
As mentioned previously, Sirius cannot seem to catch a break. As the demise of satellite radio as a result of new emerging technologies continues to be written about, Sirius has to now face a trial to contend that it is not a monopoly.
These royalty fees that have prompted the suit have been absorbed by Sirius since 2007, before they were passed on to the subscriber starting in 2009, as it was forced to do so by the Federal Communications Commission as a condition of the merger. So Sirius is essentially being sued for following government orders.
From trial documents, we learned that when Sirius and XM sought to merge, they made several “voluntary commitments” in pursuit of FCC approval. One of these commitments was a promise to not raise the $12.95 base subscription rate for three years following the merger. However, due to significant increases in royalty costs, Sirius felt it needed to limit the term of the price-cap to one year only for royalty-related fees. One year after the companies merged, Sirius imposed a royalty-related fee, which we know as the Music Royalty Fee (MRF).
The plaintiffs are suing Sirius and contending that in calculating the MRF, Sirius used a "cost-based approach" as opposed to a "rate-based approach". They continue to allege that Sirius used this approach to bill what they are considering “inflated MRF” for a longer period of time than would otherwise have been necessary. This left me scratching my head a bit and wondered what difference this would have made.
Nevertheless, at the onset, the court correctly rejected their arguments that this was deceptive, because the language of the MRF explanation does not distinguish between increases due to rate hikes and increases due to additional music demands. In fact, the MRF explanation is consistent with what is imposed as recoupment costs and non-rate increases, and does not limit the MRF to passing along rate increases. They failed to show that the MRF recovers fees beyond Sirius’ increased royalty costs.
As earnings approach, investors should expect solid numbers from Sirius. ARPU is projected in the range of $11.81 to $11.83, or up $0.02 quarter-over-quarter and up 3% year-over-year. Even as the trial approaches, it will help that Sirius did in fact reduce the MRF form $1.98 to $1.40 for 60% of its subscribers. Q4 results showed investors that Sirius is confident in its metrics, and the solid auto numbers so far in the year will likely be a key reason to expect an upward guidance.
The stock is currently trading at 17.9x 2011 EV with a long term EBITDA growth rate of 24%. I mentioned in previous articles that Liberty Media (LCAPA) in on board with its 40% holding and appears to be interested in increasing its stake if SIRI slips and accessing the $8 billion NOL. In light of all of the above, it is worth noting that two of the plaintiffs have since withdrawn from the case. It seems that they agree with me, and it’s looking like a non-event.