Pandora And Sirius XM: There Is No Reason Why They Cannot Coexist

Includes: P, SIRI
by: Helix Investment Research

It is natural that certain stocks elicit more emotion from investors than others. But it is not necessarily beneficial. When it comes to investing, emotions can cloud an investor's judgment, distorting their sense of reality, and can lead to mistakes and losses.

Here on Seeking Alpha, perhaps no 2 stocks garner more emotion an attention than Sirius XM (SIRI) and Pandora (P). Rarely does a day go by without a new debate emerging over which company is better. Supporters and critics of both companies, from what we have seen, have a fervent desire to see either Sirius XM or Pandora fail, depending on which camp they are in.

Frankly, we see no reason why this is the case. Sirius XM and Pandora are both good investments, in our opinion, albeit for different reasons and time horizons. At the present, the two companies have different business models, and are seeking to target different markets. The fact that they both offer users access to music is not enough to make them competitors. We fail to see any legitimate reason why one company has to fail for the other to succeed, and have positions in both companies, for we think that each has the potential to deliver profits to shareholders.

Pandora: Long-Term Time Horizon, Long-Term Potential

We have been bullish on shares of Pandora for some time, first recommending the shares in February. It is undeniable that since then the stock has moved against us, but we have been adding to our position in Pandora on the way down, particularly after the last quarter's earnings were released. We have always stressed that unless you are trading in and out of Pandora constantly, Pandora must be seen in a long-term context. Our bullishness on Pandora centers around the belief that the company can reach an inflection point in mobile advertising. We provide a quick overview of the company's financials below.

Pandora Financial & Operational Results

Q4 2012 Q4 2011 Fiscal 2012 Fiscal 2011
Ad Revenue $72.053 Million $41.481 Million $239.957 Million $119.333 Million
Ad Revenue Growth (%) 73.7% N/A 101.08% N/A
Subscription Revenue $9.273 Million $6.160 Million $34.383 Million $18.431 Million
Subscription Revenue Growth (%) 50.54% N/A 86.55% N/A
Total Revenue $81.326 Million $47.641 Million $274.340 Million $137.764 Million
Total Revenue Growth (%) 70.71% N/A 99.32% N/A
GAAP EPS -$0.05 -$0.31 -$0.19 -$1.03
Non-GAAP EPS -$0.03 -$0.01 -$0.02 $0.00
Listener Hours 2.7 Billion 1.3 Billion 8.2 Billion 3.8 Billion
Operating Cash Flow $2.396 Million $1 million $5.878 Million $3.222 Million

It is crucial to note that although Pandora is not yet profitable on a GAAP basis, the company is posting growing operating cash flows, allowing it to finance the continued investments needed to grow the business.

There has been much debate surrounding whether or not Pandora's business model is viable. We believe that in the long run, it is. The greatest threat to Pandora comes from content costs, which rise in tandem with its revenues, for the more users Pandora has, the more it must pay in royalties. Content costs rose 101.25% in the last quarter, to $48.169 million, whereas revenue rose just 70.71%. This dichotomy is Pandora's biggest challenge, but we believe that pessimism about whether or not the company can weather this is overblown.

Mobile: The Next Frontier

The advent of the iPhone revolutionized not only the smartphone industry, but Pandora's business as well, in both positive and negative aspects. On the plus side, Pandora's share of American radio listening has been able to grow to 5.74% as of February 2012, and mobile users now account for over 70% of Pandora's usage. On the negative side, mobile usage has lower RPMs than the traditional desktop business. RPM in fiscal 2012 came in at $20, compared to $13 in fiscal 2011.

Furthermore, mobile revenue quadrupled in fiscal 2012 to $100 million. In the long run, there is little material difference between the monetization potential on the mobile side of Pandora's business compared to its desktop business. Once user growth reaches a more modest pace in the mobile business, monetization should improve. And as growth in users falls, so to will growth in content acquisition costs. This is why Pandora must be seen as a long-term holding. The primary driver of long-term profitability will take several years to play out.

Recent Developments

Since reporting its fiscal 2012 results, Pandora has announced several initiatives designed to expand its reach and advertising market. Pandora has announced that more than 400 local advertising campaigns have been confirmed to run so far this year. One of Pandora's goals for 2012, as outlined on its conference call, was to invest in its local advertising salesforce, as well as marketing.

In addition, Pandora has inked a deal with Suzuki to install Pandora in the majority of Suzuki's 2013 vehicles, which will be available starting this fall. And on April 11, Pandora and Intel (INTC) announced a partnership in which users will be able to experience their music in a closer way than before and share it with those around them.

The Long Run

We once again emphasize that Pandora is a stock for patient investors who are willing and able to hold it for at least several years. This article is by no means meant to be a complete analysis of Pandora. For readers who wish to learn more about why we feel Pandora is a worthwhile investment, our prior articles on Pandora are available here and here. Now, we turn to Sirius XM.

Sirius XM: The Healing Process & Preparations for the Future Continue

For Sirius XM, the past several years have been marked by recovering from near bankruptcy in 2009. Shares of Sirius XM fell to as low as 11 cents before they bottomed. It was then that John Malone and Liberty Media (NASDAQ:LMCA) stepped in to save Sirius XM, acquiring a 41% stake in Sirius XM in the process. There has been an enormous deal of speculation about what Liberty is going to do in the months to come. Will it sit and do nothing? Or will it take action and acquire the remainder of Sirius XM that it does not own? Many signs point to the fact that Liberty will make a move.

After all, Sirius XM is sitting on billions in net operating loss carryforwards, something that Liberty would very much like to get its hands on. Perhaps no company, save GE (GE), is as adept at avoiding taxes as Liberty Media. As such, Sirius XM would benefit Liberty in this regard, to say nothing of the benefits that come with owning Sirius XM outright. For readers interested in a more in depth look at Sirius XM and our bullish thesis, our previous article on the company can be accessed here. Our position in Sirius XM was initiated recently, on the back of recent developments involving Liberty Media, which we will discuss later. Before we continue, we provide a brief overview of Sirius XM's financials below.

Sirius XM Financials, 2008-2011

2008 2009 2010 2011
Revenue $1,663,992,000 $2,472,638,000 $2,816,992,000 $3,014,524,000
EBITDA N/A* N/A* $626,288,000 $731,018,000
Net Income -$5,313,288,000** -$342,790,000 $43,055,000 $426,961,000
Diluted GAAP EPS -$2.45 -$0.15 $0.01 $0.07
Subscribers 19,003,856 18,772,758 20,190,964 21,892,824
ARPU $10.56 $10.73 $11.73 $11.58
GAAP Subscriber Acquisition Cost $74 $63 $59 $55
Churn 1.8% 2.0% 1.9% 1.9%
New Vehicle Customer Conversion Rate 47.5% 45.4% 46% 45%
Free Cash Flow -$551,771,000 $185,319,000 $210,481,000 $415,742,000
Diluted Shares Outstanding 2,169,489,000 3,585,864,000 6,391,071,000 6,500,822,000

*Sirius XM did not break down EBITDA for 2008 and 2009
** Net losses in 2008 include $4,766,190,000 in goodwill writedowns

Sirius XM is steadily recovering, and 2012 should be another good year in terms of financial performance. Free cash flow is expected to reach $700 million this year, allowing for the company to continue deleveraging itself and investing in the business. EBITDA is forecast to come in at $875 million, and revenue is expected to reach $3.3 billion, for growth of 9.8% from 2011 levels.

Recent Developments and the Road Ahead

It is important to remember that even though Pandora may seem to have the cachet of being the young and new company in this sector, Sirius XM is not sitting still. 2012 is shaping up to be an important year for Sirius XM, and there are a number of initiatives planned to expand Sirius' reach, as well as grow revenue and profits.

The first is Sirius XM's mobile streaming service, which will cost users an additional $3 per month. The revamped service will include personalized music in the style of Pandora. Although this may seem like a direct shot across Pandora's bow, we do not see it that way. Sirius XM recently instituted a 12% rate increase, and one of the side effects of that is a projected rise in churn, from 1.9% to 2.1%. To counter this effect, Sirius XM is revamping its streaming service, in order to derive incremental revenue increased from its existing subscriber base. Stealing users from Pandora is not the goal of this service.

Sirius XM is also working to strengthen its presence in the automotive industry, arguably the most important aspect of Sirius XM's business at the present moment. Sirius XM recently inked a deal with Chrysler in which Chrysler will have exclusivity to install Sirius XM's new line of radios for the next year. Sirius XM says that 67% of new cars come pre-installed with its radios, up from 62% a year ago.

The company is also making inroads in the used car market as well. Currently, the company has partnerships with over 4,000 used car dealerships across the country, and this business should grow in the years to come. We turn now to recent developments regarding Liberty Media.

Liberty Media: A Soap Opera of Profits?

Much of the bullish thesis surrounding Sirius XM over the past several years has been predicated on an eventual takeover of the company by Liberty Media. And recent events have elevated the drama surrounding the relationship between these 2 companies.

In early April, Liberty Media petitioned to gain de facto control of Sirius XM via filings with the FCC, asking to gain control of Sirius XM's licenses. Sirius XM has naturally responded, petitioning the FCC to deny the request. According to Citigroup analysts, the typical timeline for FCC responses to such a request puts the timeline in this case to October. These developments indicate that the relationship between Sirius XM and Liberty is souring. In fact, Liberty notes in its filings that Sirius XM is refusing to cooperate (unsurprisingly) in providing needed information to transfer control of the licenses.

However, this should be interpreted in a positive light. Liberty's bid for de facto control sets the stage for it to assume de jure control of the company, and Sirius XM's stance is likely posturing by the company's management and board to extract as large of a premium as they can from Liberty. We believe that by the end of 2012, there will be some sort of change in the relationship between these 2 companies. Perhaps not a full takeout as some Sirius XM investors wish, but it will likely be a change nonetheless.


Many people see Pandora and Sirius XM as competitors, and believe that one must fail in order for the other to succeed. We do not see it that way. These 2 companies are going after different markets, and though both are making inroads in the automotive industry, we do not think that they are threats to each other at this time. Pandora is steadily growing its business, and is working very hard to increase mobile monetization. Once user growth subsides, growth in monetization will accelerate.

We continue to believe in the long-term potential of Pandora's model, and think that patient investors who buy in at these levels will be rewarded. And Sirius XM is steadily recovering from the crisis it faced in 2008 and 2009. The company is healing financially, and is working to expand its subscriber base and generate increased revenue from its existing subscribers. And recent developments with Liberty Media suggest that a change in its relationship with Sirius XM may be on the way.

We believe that both Sirius XM and Pandora have a good deal of value to offer shareholders, and that is why we are invested in both of these companies, and believe that others should be as well.

Disclosure: I am long P, SIRI, GE, INTC.

Additional disclosure: We are long GE and INTC via the SPDR Dow Jones Industrial Average.