Sirius XM's Recent Suit Against SoundExchange May Be A Trojan Horse

| About: Sirius XM (SIRI)

Lawsuits should not be used to destroy a viable and independent distribution system. The solution lies in the marketplace and not the courtroom.
- Don Henley

Click to enlargeOn Tuesday satellite radio giant Sirius XM (NASDAQ:SIRI) sent a clear message to investors and its competition by filing a lawsuit against two music-industry groups in SoundExchange as well as American Association of Independent Music or (A2IM) as first reported by PRNewswire. By now, I'm certain that you are aware of the verbiage and the various legalities within the press release. So before we dig further into this report, let me first answer the most important and obvious question that should matter to investors with this news - what does it mean for the stock price? Answer, absolutely nothing.

Cutting out the middle man

Though a victory may add a slight increase to its bottom line via a reduction in royalty payments by 1 to 3 percent, its impact on its share price will be negligible at best. So let's not get ahead of ourselves here and really keep things in perspective. Sirius has not made any claims as to being the victim of any action to the extent where compensatory payments are required to offset damages. Sirius said it is mainly seeking injunctive relief to stop SoundExchange from setting the price that it pays for royalties:

SiriusXM is primarily seeking injunctive relief to stop SoundExchange and A2IM from impeding its efforts to obtain the licenses it needs to operate its business in direct dealings with record companies instead of relying exclusively on licenses either negotiated with SoundExchange acting as the record industry's collective or on the outcome of regulatory rate-making proceedings.

In other words, Sirius wants to cut out the middle man so it can negotiate royalty payments directly with the record companies themselves while suggesting that the current arrangement is designed to choke off competition. This is strictly a business move and one where if the company wins it may actually benefit the competition as well. These include names such as Pandora (NYSE:P), iHeart Radio and various other smaller IP distribution platforms that can benefit more from the royalty reduction.

A Trojan horse?

So the interesting irony here is that while Sirius' claim in the suit surrounds the idea that the current arrangement with SoundExchange and A2IM inhibits competitive environments, a win by Sirius also increases the chance that its major competitors become better positioned to compete against it. Sirius' management are smart people and I'm sure that they understand this exact scenario. So the question is why is the company doing this? Especially now since Mel recently explained on Jim Cramer's show how easy it is for IP competitors to start up and compete? Why now give them an extra advantage by helping to lower their startup costs? This can't be good business can it?

Well, it is if your company's mantra is "cash is king" and your entire success revolves around your growing Free Cash Flow - then it makes perfect sense. Sirius is basically saying that the two organizations violated Section 1 of the Sherman Act. But this is not going to be something that can easily be proven as it often involves several assumptions and/or "interpretations." Be that as it may, the prize in this suit is the possible reduction in royalty payments which now stands at the 8 percent statutory rate for master rights owners. A victory by Sirius can possibly reduce this rate by as much as 3 percent - hence, increased margins and more free cash flow. But as stated, Sirius still has to prove the merit of the suit and how it is interpreted.

More importantly, investors have to understand that this is nothing new and this latest complaint only renews what has been an ongoing battle between Sirius XM and the recording industry groups - one that involves the National Association of Broadcasters or "the NAB." This fight has been going on prior to the merger of both Sirius and XM which has complained along with several IP radio competitors that royalty fees are too high. But still, I'm questioning why does Sirius feel now is the time to be a martyr? I guess it feels that helping its smaller competitors is a risk worth taking if it is also going to also result in growing its free cash flow. But will this end up proving to be a Trojan horse of sorts?

What Sirius faces

Investors have to also focus on what Sirius faces in the future in terms of royalties. According to the lawsuit, SoundExchange plans on not only fighting the rate reduction charges, but it is seeking to increase the rates from what is now 8 percent to possibly 13 to 20 percent for the period of 2013 -2017. I think this is the biggest component of the suit that investors need to pay attention to. SoundExchange also wants that percentage to exclude a carve-out for any direct licensing deals that Sirius is successful at signing. What this means is that Sirius would essentially be forced to pay the music it licenses directly twice - once to SoundExchange and then again to the right holders.

A SoundExchange spokeswoman declined to comment, saying the group can't immediately discuss the allegations until it receives SiriusXM's complaint. "Based on what we've read in the press, however, Sirius XM's claims appear to be wholly without merit," the spokeswoman said.

Summary

Ok, so basically we have two sides to this story and both sides are protecting their own interest. It will be left up to a judge to determine who is right, what is fair, what claims are legitimate and which ones are false. Now for Sirius, in alleging that SoundExchange and A2IM have violated anti-trust laws, the burden of proof is on its shoulders and it needs to justify its interpretation of the act - particularly section 1 since it alleges that the defendants have caused it economic harm. What Sirius is likely to win if it does are two things - first, it will have the defendants pay its legal fees and second, it would have helped its competitors by lowering their startup costs and expenses. For investors, aside from another suit, there is really nothing to get excited about.

Disclosure: I am short SIRI.