Sirius: 2 New Headwinds Could Dampen Gains

Jun.27.12 | About: Sirius XM (SIRI)

Sirius XM Radio (NASDAQ:SIRI) has come up with a way to reduce losses at its money-losing Canadian operation. The Toronto Globe & Mail reported that it has petitioned the Canadian Radio-television and Communications Commission (OTCPK:CRTC), Canada's version of the FCC, for permission to cut the fees it pays to artists by about 90%.

A filing that the Globe & Mail obtained from the commission could seriously damage Sirius' stock value. In the filing, Sirius admitted that it has been losing money at a disturbing rate. The filing indicated that Sirius has paid artists and their agents $52 million over the past seven years. That is $20 million more than commercial radio stations in Canada paid to the commission.

The commission collects royalties that musicians are owed from stations and pays them to the performers and their artists. Sirius is facing stiff competition from services like Pandora (NYSE:P) in Canada. It also has to compete with Canada's government radio network, the CBC (Canadian Broadcasting Corporation), which has a launched a free music player and Stingray Digital, a free music service owned by a privately held company.

Sirius XM Canada suffered a $2.6 million loss in the first quarter of 2012, unlike its American counterpart. This may not affect Sirius' U.S. operations that much because Sirius XM Canada is owned by a separate company called Canadian Satellite Radio (XSR). Sirius Canada faces a number of challenges that Sirius XM does not - they include Canadian government regulations that require it to broadcast a certain amount of Canadian programming. It also has to divert five percent of its revenue to the development of Canadian talent.

The news of losses at Sirius XM Canada could hurt Sirius' stock. The attempt to cut artists' pay in Canada could lead to lawsuits. Worse, it could encourage some big name musicians not to work with Sirius, which could hurt its efforts to develop new programming.

Sirius and AT&T Make Deal to Limit Interference

Sirius XM and AT&T (NYSE:T) have made a deal that should limit interference with Sirius' broadcasts. AT&T has agreed to give up about 10 MHZ of unused wireless spectrum, which should create a guard band to ensure a clear Sirius signal. The deal would give AT&T some more spectrum for its 4G LTE network.

The deal has to be approved by the Federal Communications Commission (FCC). It isn't clear how this deal would affect Sirius' stock value because it may not affect the company or its cash flow. It could help AT&T's cash flow because it would spare the telecom from having to buy extra spectrum from a company such as Clearwire (CLWR) or Dish Network (NASDAQ:DISH).

AT&T apparently has a shortage of spectrum for its cell phone and smartphone operations. That could put it in a disadvantage in the competition with Verizon Communications (NYSE:VZ), which has a huge amount of unused spectrum to play with. It is not known whether the FCC will approve this deal or not. If the FCC approves the plan, it could boost AT&T's stock value.

Sirius is One of the Most Traded Stocks

Sirius is currently one of the most traded stocks on Wall Street, according to Richard Saintvillus, a columnist for the Street. Saintvillus estimated that around 50 million shares of Sirius were being traded on a daily basis. He also noted trading volumes had fallen by about 50% in early June.

Like a number of observers, Saintvillus blamed Sirius CEO Mel Karmazin for the high trading volume. He estimated that Karmazin has sold around 25 million of the 60 million stock options he holds.

This trading volume appears to be what is keeping Sirius stock values low. Saintvillus noted that Sirius shares lost about 10¢ in value every time Mel sold some shares. That means future losses could be determined by the number of times Karmazin sells them. If he sells several large numbers of stock, Mel could bring down the price by another 40 to 50¢.

That could be a buying opportunity for investors, but it will be music to the ears of John Malone. Malone's Liberty Media (NASDAQ:LMCA) is trying to get full control of Sirius by buying up all its stock.

The only thing that could lead to a real increase in share value for Sirius would be decreased volatility. With Malone and Karmazin battling for control of the company, that's highly unlikely. The most likely outcome for Sirius will be lower stock values in the short time, followed by a Liberty takeover.

Spotify Enters Internet Radio Market

Pandora and Sirius now have some serious competition in the internet radio market. The privately-held Swedish music streaming company, Spotify, has announced it will offer online radio stations that is similar to Pandora.

This could be really bad news for Pandora because Spotify has an incredibly large number of songs in its database (around 16 million, according to Wired). Pandora only has one million songs to offer. Spotify's announcement could be bad news for Pandora, which is still developing cash flow. Spotify's service will be called SpotOn Radio and it requires a premium subscription.

CNN reported that Spofity has already lined up an impressive list of advertising, including Verizon (VZ), Taco Bell, Progressive Insurance (NYSE:PGR), McDonald's (NYSE:MCD), Heineken (HINKY.PK), and Chevrolet (NYSE:GM). That means its service is already generating some revenue and taking money from traditional radio stations.

Spotify would also be serious competition for terrestrial radio operators, such as Cumulus Media (NASDAQ:CMLS) and CBS Radio (NYSE:CBS). Recent news stories have indicated that Pandora is now the most popular radio station in some U.S. markets, including Los Angeles. If Spotify can develop the kind of listener base that Pandora already has, it could put a serious dent in terrestrial radio's revenue streams.

Sirius would be less threatened than Pandora because music is only one of several programming options that it offers. Unlike Pandora, Sirius has such attractions as sports, news, comedy, and talk to lure in listeners.

This could be the start of intense competition between Spotify and Pandora. It is unclear if either Spotify or Pandora has the cash to sustain such a battle. Pandora, in particular, will have to spend a lot of money developing an advertising sales effort. Any intense competition with Spotify will eat up Pandora's cash and undermine its share value.

This development could finally be what drives Pandora to start offering something besides music. That too would hurt Pandora's stock value because it would have to spend a lot of money to buy sports or talk programming. It is unclear whether Pandora has that money or the ability to leverage resources to get it.

Pandora Trying to Change Music Royalty Rules

Pandora is making a serious attempt to address one of its biggest problems: the high fees it has to pay for music. The LA Times reported that the online radio network has spent $50,000 lobbying Congress in an effort to change the fee structure.

It is easy to see why Pandora is spending that money; it had to pay 50% of its revenue to recording artists and their agents in 2011. Sirius, on the other hand, only had to pay 7.5% of its revenue to musicians.

Pandora's co-founder, Tim Westergren, testified before a House of Representatives committee in early June and outlined the changes he'd like to see. Mr. Westergren would like to see a level playing field in which all forms of radio pay the same royalty rate for music. Under the current system, Pandora has to pay through the nose for songs, while traditional over-the-air radio stations pay nothing.

If Congress were to give Pandora what it wanted, the stock values of radio station operators like Cumulus would certainly fall. Pandora itself would see an increase in stock value because it could negotiate deals with artists and their agents. That would enable the company to keep more of its cash, which should boost its profits and stock values.

It is unlikely that Congress would go along with Pandora's demands because of opposition from radio stations and the music industry. This story indicates that Pandora is desperate to contain costs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.