Yet another investment debate has been hijacked by the allure of cultural popularity, cheap money, cutting-edge technology, and grandiose personalities, at the expense of nuts and bolts bottom line profits. John Malone, Mel Karmazin, and Howard Stern are the headline acts of this looming Sirius XM Radio (SIRI) tragedy. As supporting characters, Apple (AAPL), Google (GOOG), Facebook (FB), and Pandora (P) will unite beneath a Web 2.0 complex that proves to be the ultimate foil to Sirius' future as a viable enterprise. Major players run the risk of throwing billions of dollars into an outdated business model that is going the way of ham radio.
In February 2009, Mel Karmazin, Sirius CEO, was lording over a stock that traded for pennies on the dollar, while also fielding calls from anxious creditors. At the eleventh-hour, billionaire John Malone financed a $530 million loan through his Liberty Media (LMCA) vehicle, in exchange for preferred stock convertible into 40% of Sirius stock. Sirius XM shares now change hands at $2.50. This price values this satellite radio company at $9.8 billion, in terms of Wall Street market capitalization. After preferred stock conversions and aggressive open market purchases, Liberty Media now owns a shade less than 50% of Sirius stock. Malone has already banked more than $4 billion in profits on his original investment. Instead of cashing out at the top, John Malone is now lobbying the Federal Communications Commission (FCC) to approve his appeal for an outright acquisition of Sirius Radio.
Long-term investors should not allow themselves to be distracted by this smoke and mirrors side show. Not even the legendary John Malone can save Sirius XM Radio from Web 2.0 competition. This is survival of the fittest capitalism.
The Web 2.0 Business Model
Web 2.0 infrastructure supports customized interaction, where private users are free to produce and share their own content. Citizen journalists and aspiring musicians are now capable of selling online production through a meritocracy, where earnings are distributed according to traffic. Alternatively, amateurs typically opt to give away content for free, as means to socialize and market a burgeoning career. At center, the Web 2.0 platform is effectively a broker-dealer that sells goods directly, while also aligning a specific user base with third-party advertisers.
Facebook, with its 955 million users and flagging stock, is the capstone event of this Web 2.0 movement. Despite their popularity, Facebook, Pandora, GroupOn (GRPN), and Yelp (YELP), have been unable to leverage the Web 2.0 user base for significant profitability. Basic Economics 101 would indicate that the value of aggregate media and entertainment is on the decline, as the supply of digital content increases. Interestingly, Apple is now the most financially successful conduit of Web 2.0 data.
For its latest third fiscal quarterly period ended June 30, Apple reported sales of 6.7 million and 26 million iPhone and iPod units, respectively. Taken together, the iPod, iTunes, and iPad platforms accounted for $19.4 billion of Apple's $35 billion in Q3 2012 revenue. Alternatively, Pandora, Facebook, and GroupOn lurk beneath the shadows of Apple's financial success and blame mobile for the cannibalization of Web 2.0 profits. As an entertainment center, the iPhone dock amplifies sound through earphones, standalone Bose speakers, and automotive consoles. This expansion of the do-it-yourself digital medium is End Game for satellite radio and Big Media, at large.
On September 21, Gallup released results of a poll indicating that American distrust of our media is now at an all-time high. According to the data, 60% of all Americans have little to no trust in newspaper, television, or radio communications. Amid election season, only 31% and 26% of Independents and Conservatives, respectively, can relate to the media with a "fair amount of trust." For Sirius, trending alienation towards Big Media threatens to destroy its subscriber rolls and advertising revenue.
Future Plans for Sirius XM Radio
Jeff Bercovici and Forbes Magazine describe the Mel Karmazin - John Malone working relationship as a war between two opposing ideologies. Apparently, John Malone's long-term Sirius vision includes heavy investments towards enhanced Internet infrastructure, in order to compete with the digital platform. Mel Karmazin, however, appears content to manage Sirius as a terrestrial radio outfit. As such, Karmazin's operational style leverages star power handshake deals with the likes of Howard Stern, Martha Stewart, Oprah Winfrey, Eminem, and 50 Cent. Somewhat behind the scenes, a Yahoo Finance report shows Karmazin regularly exercising Sirius options at 43 cents per share, and immediately selling stock to bank millions of dollars in profits.
Greg Maffei, Liberty Media CEO, is dismissive of the "historically expensive" Mel Karmazin, who took down $43 million in 2009 executive compensation. According to Maffei, "the graves are full of irreplaceable people." This tough talk indicates that Karmazin will be promptly shown the door after the proposed Sirius acquisition. Investors should therefore acknowledge the finality of John Malone's operating regime. At this point, Sirius shareholders should not expect to collect upon a significant premium from Liberty Media, which now wields de facto control. Liberty Media investors may stand to profit, if Malone closes on Sirius, only to slash costs, and spin off this satellite radio business to an enamored buyer at a later date. Media mogul John Malone, of course, has built his reputation largely through efficient operations management and financial engineering.
In a recent Wall Street Journal interview, John Malone exclaims, "control is control is control is control." As an executive, Malone's modus operandi states that "whole life is about control."
The Bottom Line
Sirius XM Radio closes out its fiscal 2011 books with a blockbuster performance, considering the fact that Liberty Media cash rescued this company from the brink. In 2009, Sirius lost $5.3 billion. For this last fiscal year, Sirius reports a record base of 21.9 million subscribers alongside $427 million in profits and $544 million in operating cash flow. In his letter to shareholders, Mel Karmazin highlights improved marketing within the pre-owned vehicle sector, new automotive sales, and satellite radio price increases, as important drivers of bottom line growth.
Contrary to the euphoria surrounding Sirius XM Radio stock, this business still faces a plethora of long-term challenges. In the near-term, all U.S. GDP growth estimates are being revised downward despite Ben Bernanke and the Federal Reserve Board's latest quantitative easing program. Amid recession, cyclical automotive sales will decline sharply and stymie John Malone's turnaround efforts. Recent reports out of China, India, and Western Europe highlight weak automotive sales in line with a slowing global economy. Contagion from the Euro-Zone crisis, of course, directly threatens consumer confidence and Sirius' fragile business model.
Cash-strapped consumers are likely to postpone big-ticket purchases and cancel satellite radio subscriptions. As part of their monthly service contract, savvy tech enthusiasts can always opt to rig free Web 2.0 streaming radio, YouTube videos, and pod casts through smart phone handsets and speakers. For its latest second quarterly fiscal quarter, Pandora reports a loss of $5.3 million on $101 million in revenue. The prior quarter, Pandora fared even worse, with a relatively staggering $20 million in losses. At present, Pandora is effectively forced to dump product onto the market, as incoming advertising revenue cannot keep pace with listening hours and licensing fees on streaming music. Pandora actually stands to lose more money, as it gains in popularity. Pandora is the canary in the coalmine, for Sirius Radio and its visions of grandeur.
As an added bonus, John Malone's aggressive buying establishes a built-in put on Sirius stock. Ironically, Sirius may already be overvalued, largely due to Malone's own aggressive buying. Even at a meager 5 times earnings, Sirius would quickly degenerate into an albatross for Liberty Media, when satellite radio and digital music prove difficult to monetize.
Maybe John Malone and Sirius investors should quit while they are ahead.
Disclosure: I am long AAPL.