By Robert Weinstein
Is iTunes Sirius Radio's next Problem? Who Else Will Feel The Impact?
You may have read that Apple (AAPL) is reportedly maneuvering to rival Pandora's (P) online radio streaming service. Pandora investors initially didn't enjoy the thought of Apple entering their space as shares plummeted well over 25% during the following three days of trading after the news hit the wire.
Sirius XM Radio (SIRI) also watched its shares fall, but not nearly with the same force or panic encompassing Pandora. Both Sirius and Pandora have effectively shaken off the initial fear that swept in.
Investors shouldn't be surprised that their shares have rebounded so quickly. After all, knee jerk reactions based on rumors of something that may happen in the future are rarely correct.
Trades based on an event that may happen sometime in the future are my favorites to fade and those that were shaken out of Pandora under $10 a share, or Sirius under $2.40 now fully comprehend why.
The first question investors need to ask is if Apple, a company selling products with an operating margin of 35%, has an interest in adding a product line that does not appear to provide anywhere near that level of opportunity. Pandora, for example, currently is only capable of a negative operating margin.
Don't forget, Pandora lost money in the latest quarter. Even with the proverbial light at the end of the tunnel within view, it may just be an oncoming train ready to smash into Pandora investors head-on. Pandora reported losses last quarter in excess of $5 million, based on revenue of slightly over $100 million.
Even if you give Apple the benefit of the doubt and concede that they will execute at a higher level, opening this market up doesn't make a lot of sense from a resource allocation requirement viewpoint. Apple sells more music content than any other company, and it's reasonable to assume they are able to negotiate a more favorable royalty contract than Pandora pays.
How much better is a serious question, because the subject isn't only debated at the company level - Congress is a player. If the record labels are willing to give Apple a sweetheart deal, Pandora can cry foul to Washington.
Any way you listen to it, the song remains the same. A drop in royalty payments for Apple will almost assuredly result in lower overall revenue for the record labels.
Remember that if Apple travels down this path, there is always the opportunity cost that must be paid regardless if Apple is able to make it work or not. Is Apple willing to devote the needed resources into a business model that promises margins of 10%, maybe less? Not from my vantage point.
Let's look at another prime example of the subscription model. Netflix (NFLX) streams movies on a subscription basis. Is Netflix making money? And more importantly, is Netflix making the kind of money that encourages new entrants using the same model into the space? No, on both counts.
If you own a Roku, you likely know there are alternatives to Netflix and the big boys like Amazon (AMZN), Apple, and Hulu. But, Netflix is by far the largest and most well-known name in streaming TV content.
If the largest and most well-known companies in streaming content like Pandora and Netflix are unable to realize outsized margins and profit, you can be sure Apple isn't really thinking of moving into direct competition with Pandora. Not at least with the same model.
This isn't the first time Apple has explored this subject, and granted the rumor mill is writing at full speed "this time is different," but I believe the most reasonable way one may consider this time different, is if the entire model is different.
Sirius subjects listeners of some content to advertising (at least they did at the time I allowed my subscription to expire). It's possible that Apple believes a subscription model that includes advertisements pushes the idea "over the top".
Currently Pandora removes commercials when a subscriber pays for a premium service level. Could a model work with both ads and subscriptions? Aside from Sirius' limited example, maybe Hulu Plus provides the best example.
The Hulu Plus subscriber base was about 1.5 million at the start of 2012, and by April, the subscriber base stood at 2 million. At the same rate of growth, it's reasonable to assume Hulu plus is over 2.5 million paying subscribers.
Unlike the Netflix model of every viewing of content costing Netflix money (Netflix uses Amazon servers to deliver content), Hulu makes money beyond the monthly subscription cost each time content is delivered to the consumer.
If Apple is able to take the Hulu model and apply it to online radio streaming, it very well may be said that this time is different.