I'm not one for wild speculation. That said, I'm all for looking at competitive spaces and companies' positions within those spaces to see what type of M&A activity makes logical sense.
In this article, I put forth three M&A scenarios that could work for the companies involved come 2012.
Straight away, I don't think Liberty Media (LMCA) makes any drastic moves on Sirius XM in 2012. That said, Sirius XM CEO Mel Karmazin is on record that he will consider an acquisition in the New Year.
On the surface, ardent Sirius XM longs, who I lovingly refer to as the "peanut gallery," will trash me for making this suggestion, but just hear me out.
First things first. I love to brag when I am frighteningly right, which was the case with Netflix (NFLX) in 2011. However, I have no problem exposing myself when I miss the mark. As Clear Channel's (OTCQB:CCMO) iHeart Radio and Spotify smartly forge ahead, they, coupled with the company's day-to-day issues, continue to paint Pandora into a bit of a corner. While I still believe in the power of Pandora's multi-platform, local-national advertising potential (and am still long the stock), I'm not quite as giddy about Pandora's prospects as I once was in the face of these developments.
Simply put, Pandora could probably use some firepower behind it. And Sirius XM would definitely be well-served by freshening up its approach via a larger, more diverse audience.
A merger takes Sirius XM and Pandora to the next level in several ways:
- It provides Sirius XM access to Pandora's considerable audience, much of which resides in the 18-34 year old demo. By cross-promoting the two platforms - and possibly sharing some features - Sirius XM gains instant access to this younger demo, while Pandora could make some Sirius programming part of its platform. Picture Howard Stern available through Pandora; his audience doubles, at the very least, overnight.
- Buying Pandora gives Sirius XM instant entrance into the advertising space without compromising its commercial-free stations.
- Mel Karmazin knows a thing or two about building sales teams and creatively selling advertising. Pandora sits at a crucial stage in its development as it puts together a sales force to aggressively take advantage of the growth not only in web spots, but, more importantly, the soon-to-explode mobile space. Now an ad buy does not merely include Pandora or Sirius XM as single entities; the merged company could offer advertisers exposure to both audiences across platforms and a diverse set of demos.
- A merger could change the game with relation to music royalties. A combined Sirius XM-Pandora opens up the possibility to negotiate a royalty rate that makes more sense for both companies. As one, the companies have much more leverage than they would have on their own.
- The merger would create a diversified powerhouse in the audio entertainment space. Combine Sirius XM's 21 million subscribers with Pandora's 40 million active users (both, as of the end of each company's last reporting period) and the reach of both companies immediately expands exponentially.
Companies (and investors) should not underestimate the significance of Clear Channel's move to include all of Cumulus Media's (CMLS) radio stations on its iHeart Radio application. This sends the message loud and clear from terrestrial radio that we're stronger together than we are as one if we want to compete effectively in the broad audio entertainment space.
Going forward in the space, it seems almost impossible to fly solo unless you're a juggernaut like Apple (AAPL) or a tinkerer like Google (GOOG). While the emergence of satellite radio 2.0 features on Apple devices brings a sense of euphoria to some current Sirius XM subscribers, it will likely do very little to drive new sign-ups. The ability to better schedule, stop, start, play and pause content you already took a pass on does not make that content any more attractive.
The next step for Sirius XM should focus on improving its content, not cutting costs by diluting it. Karmazin needs to work to recapture the magic satellite radio promised as a markedly different and superior alternative when first conceived. Random, albeit excellent, programming moves the company makes do not cancel out the reality that some of its talk stations sound like college radio and many of its music stations use tactics that made the world hate Clear Channel, such as tight playlists and voice-tracking. You can get the rest of its content (i.e., sports, traffic, weather) elsewhere for free or via existing platforms you already routinely pay for like a utility bill.
Simultaneously, the company needs to work to aggressively expand and diversify its audience. There's no reason for it to continue to niche itself to the 35-64 year old demographic. This approach guarantees long-term irrelevancy. A hook-up with Pandora instantly kicks open the door to the 18-34 set that Stern, for instance, dominated while in terrestrial radio. Plus, it kick-starts the online and mobile relevancy Sirius XM lacks.
A Sirius XM/Pandora merger presents a couple big insects in the ointment. One, I don't think making such a bold and aggressive move fits with Sirius XM's culture. Along similar lines, I'm not sure Pandora's founders and major investors would bow to the idea of being taken over by what amounts to an executive team of old terrestrial radio guys. While not as much as the Sirius XM merger, a tie-up between Sirius XM and Pandora could present logistical nightmares, depending how deeply integrated the two services became.
There are a number of ways a merger between Sirius XM and Pandora could play out, but the bottom line is that together they become a much more formidable force in a highly-competitive area than they do on their own.
In part two of this article, I continue along similar lines suggesting two other cases of potentially more realistic M&A activity in closely-related spaces.
Additional disclosure: I am long NFLX June 2012 $40 put options.