It's clear that the music business is far gone from the traditional model of going to the local record store and buying the latest album, but exactly what things will look like going forward is far from clear. There are certainly a lot of players out there, with different strategies to capitalize on this uncertainty.
There's of course Apple (AAPL), which has seen extremely solid numbers with its iTunes service, which charges either for entire albums or individual songs and pays record companies for the right to feature their products. Then there's streaming services like Pandora (P) and privately held Spotify, who also spend a lot of money complying with the demands of record companies.
But there's one company that stands out, a company that pays far less in royalties and is seen as being less threatening to record company profits: Sirius XM Radio (SIRI). Given that Sirius pays far less in royalties - which look like they're only going to get more expensive in the future - I think Sirius is an extremely solid stock to own going forward.
Sirius XM owes much of its advantage over Pandora and Spotify to the fact that it's set up far differently. Essentially, Sirius is set up as an analogue to traditional radio, something that music companies are completely comfortable with and embrace, the idea being that people will hear songs they like on the radio and then go out and purchase albums. With Sirius, the concept is the same, just on a far larger scale with more channels and a wider variety of content.
On the other hand, Sirius and Pandora are not looked at by big music companies the same way at all. In fact, music companies have found charging steep royalties to companies like Pandora and Spotify to be a steady revenue source in a time of uncertain profits. In an article for the New York Times, music blogger Ben Sisario explained the predicament faced by Pandora and Spotify.
With artists and labels hit hard by declining sales over the last decade, it's hard to argue for lower royalty rates," Sisario wrote. "But the graveyard of failed digital services, and the financial struggles of Pandora and Spotify show that the music industry hasn't yet figured out the balance between licensing costs and how much money a digital service can make.
So if I'm looking to invest in the future of music, I would be rather skittish about companies like Pandora and Spotify at this point. As music companies get squeezed more and more by shrinking profits, they'll look to royalty fees as some of the only ammunition they can use. Thus, while Spotify and Pandora owe their existence to the changing nature of the music industry, they also could be faced by crippling royalty costs going forward.
Sirius also has no problems raking in profits, as it has its position as a premium radio service staked out. People pay subscription fees for using Sirius in their cars, and recently Sirius began offering Sirius Internet Radio, making Sirius channels available to anyone with an Internet connection or smartphone. On the other hand, most of the people that use Spotify and Pandora don't pay anything. Spotify does have a premium subscription based service, but has yet to see sustained profitability.
While Sirius' stock price has plummeted since its peak over a decade ago, I would argue it is the better play going forward. Keep in mind that despite the difference in stock price, Sirius pulled in $3.2 billion in revenue last year, compared to only $304 million for Pandora. Shares of Sirius are up 40 percent over the past year, and though it is unclear how a potential takeover by Liberty Media (LMCA) will affect the company, many analysts are quite bullish on the future for Sirius.
The future of the music industry is pretty up in the air at this point. But traditional record companies still have the deepest pockets, and their attitude toward streaming services like Pandora and Spotify remains a bit hostile. I would feel more comfortable with Sirius going forward, as subscribers continue to grow and investor confidence begins to return.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article was written by a team member of Freedonia Freelance/Freedonia University.