Apple Strikes Deal - Audio Entertainment Sector Heating Up

Includes: AAPL, GOOG, P, SIRI
by: Spencer Osborne

Is Apple (NASDAQ:AAPL) turning the audio entertainment world on its proverbial ear? The company has been a giant in the music space ever since the first iPods came off of the assembly line. Over the past year or so, we have been hearing grumblings of the likes of Apple and Google (NASDAQ:GOOG) entering the streaming side of the music business. Google officially threw its hat in the ring about a week ago with the launch of Google All Access. It now appears that Apple is one step closer to a streaming service with its own announcement of a deal with Warner Music Group. While details are not fully available, it appears that Apple can stream the Warner library for 10% of advertising revenue.

The audio entertainment sector will be getting interesting moving forward. Former Sirius XM Satellite Radio (NASDAQ:SIRI) CEO Mel Karmazin used to state that he did not have a big worry about streaming radio services like Pandora (NYSE:P) because the business model was so challenging and profits not easily obtained on an ad supported model. His worry was if giants like Apple and Google entered the arena. That is now happening.

Royalty issues and direct deals with record labels is the topic du jour these days. Thus far, major direct deals have eluded Sirius XM and Pandora. Sirius XM went on the offensive regarding the subject in a lawsuit against Sound Exchange and AI2M alleging that the royalty aggregators were hindering the company from cutting direct deals. The suit has been settled with Sound Exchange, now being limited in what they can say to their membership about Sirius XM. Pandora has been touting the Internet Royalty Fairness Act, legislation geared toward re-dividing the proverbial revenue pie between artists, distributors, and services. Pandora seems to be facing an uphill battle as the labels have a powerful lobby and artists want to receive the maximum payment for their efforts.

The very fact that Apple has come to a direct agreement with Warner Music Group is an indication that Apple is serious about entering the streaming music space. Rumors may now begin to fly about an Apple streaming service with a built-in and passionate consumer base taking it over the top. A viable Apple streaming product can have impacts throughout the sector. The leading streaming service, Pandora, was down 10% on the news, while Sirius XM, which has a subscription model, is holding strong and only down slightly. That stock action is on the day of the news. The telling story will come when Apple and Google shift into gear.

In my opinion Pandora has much more exposure here than Sirius XM does. Pandora relies heavily on advertising. Google is the cream of the crop when it comes to advertising and Apple is a name that virtually any company would want to be associated with. If either of these giants decides to make streaming a loss leader it could decimate the audio entertainment sector as we know it. Personally, the ones headed for the exits on Pandora may have the correct strategy. They can live to fight another day and wait to see just how serious Apple and Google are in this space.

Sirius XM investors have less to worry about. The company is on solid financial footing, has demonstrated a business model that works, and is even updating that business model to offer customization beyond that which Pandora offers. The crown is Sirius XM's to lose. That does not mean that investors should not watch Apple and Google closely.

For Apple investors, the announcement of a streaming service may initially carry more excitement than it does profits. One only needs to look at Pandora's business model to see that profiting from a free ad supported model has challenges. Even with over 60 million active accounts, Pandora is hard pressed to find a profit. If a company were to pull off a free model and make it work, I would bet on Apple. Apple stock may pop as the company gets ready to stream, but I do not see an Apple branded music streaming service as a huge profit center for the company. A savvy trader can play this well. Apple will be presenting at a few events in the not-too-distant future.

Disclosure: I am long SIRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in Apple, Google, or Pandora.