Sirius XM Vs. Pandora: Apples And Oranges

Includes: P, SIRI
by: King of All Trades

By Relmor Demitrius

Sirius XM Radio (NASDAQ:SIRI) has many competitors. In this series of articles, the first of which was Sirius XM vs. HD Radio, I look to find which competitors are valid and which are fiction. I was going to write individually about Pandora (NYSE:P), Spotify and I Heart Radio, but I decided there is no point. In 6 months I’d have to talk about another start up or internet service that is going to “crush Sirius XM.” So in lieu of rewriting this article every 2 weeks, I have decided to just include all internet services in this comparison.

First we must clearly define what this segment of the competition offers: Music choices. Lots of them. Hundreds of them. There are literally hundreds of internet sites that store, hold, allow downloaded, or allow a random order of music to your computer or internet device (i.e. car, iPod, laptop, or smart phone). In fact, there are probably more internet radio options every day. The car was the latest place to add the internet. OEM manufactures didn’t want to let the other guy allow easy internet access and went further and allowed a few of the more popular programs to be accessed hands-free -- nice features for any new car. What others won’t tell you is these features are also for use with Sirius XM Radio as well, which include their weather, traffic, and entertainment data services. These can all be accessed hands-off with Ford's (NYSE:F) Sync and Dodge's U Connect as well as Pandora. So when you read somewhere that a car is “adding Pandora,” what they are really doing is adding the internet and making it easy to get to Pandora. You can get there anyway, regardless.

There are literally thousands of paid ways and free ways to access music on the internet. It has been this way since around 1994. Smart phones began allowing instant music access anywhere around 2005. The internet in the car has been around for about 2 years now on a large scale. When I say large scale, I in no way mean the majority of cars and trucks. This as a standard feature in all cars is still years and years away. Yes, all those cheap, non-discretionary-money spenders will have to wait.

Spotify entered the US market recently as a competitor of Rhapsody. Every day more and more music choices are on the internet. The internet is the huge medium for music access. Terrestrial radio entered this market with many online products as well. On November 7, 1994, WXYC 89.3 FM in Chapel Hill, NC, became the first traditional radio station to announce broadcasting on the Internet. So internet radio has been around 7 years before Sirius XM began its service. The internet itself and allowing music access through sites like have been around for decades now, even decades before Sirius XM began service. I will include internet companies like Pandora and Slacker (much better product than Pandora, not even close) as a courtesy, even though these companies are not even close to radio, nor is Spotify. CBS Radio online streaming and I Heart Radio are the main competitors here, as these are actually radio services.

What is radio? I define 21st-century radio as a two-way communication device that broadcasts content to a mass audience. Talk, sports, weather, data services, and all forms of audio entertainment define radio. Unfortunately Spotify, Rhapsody, Slacker, and Pandora-type services don’t qualify as radio. I Heart Radio and CBS Radio streaming is radio. It is just terrestrial radio rebroadcast online. So it’s simply the poor product that created the need for satellite radio in the first place on the internet. And the other sites are Napster, basically. Napster has been around since 1990s, I hate to break it to all the Spotify and Rhapsody fans. Pandora is a new concept, a random music generator. Definitely not radio, but a cute, niche, free service that has no surge in revenue potential. Too easy to mimic and no unique content. Availability is irrelevant in 5 years. Everything will be available almost everywhere on any device in 5 years. Your going to need more than “available” to make it in the future. What is radio is a good question, but let’s focus on other aspects right now.

As you can see, there are many competitors for online music. Even traditional terrestrial radio has an online presence that competes with Sirius XM. So where does Sirius XM come in? Sirius XM is a unique service that doesn’t have an equal. It is true radio. Its closest competitor is terrestrial online radio companies. Here is where they differ:

Commercials. It’s still the same radio you can get on your AM/FM radio. No difference. Doesn’t sound better, last longer, or have few commercials. They are not better DJs, fewer commercials, or anything else to differentiate itself from their broadcast airways counterparts.

Availability. Sirius XM coverage area is still the most of any music service in the United States. No close second. None.

Consistent pricing. Sirius XM has no additional charges to the consumer if you're not in a Wi-Fi hot spot. Same price in the city or in the country. Data charges start racking up for internet mobile users once Wi-Fi hot spots are not being used.

More than music. As is terrestrial radio more than music, so is Sirius XM Radio. Here is where Pandora and Spotify have to say good bye and all random music generators or music storage programs. These services do not offer human interaction. They do not offer traffic services, weather services, or allow emergency or relevant news to be communicated quickly to many people over a large area. They don’t cover the news, offer opinions, or an outlet to communicate to its listeners. Want to call in and talk about the presidential election? Pandora will not answer your phone call. Why? Because its not radio. Anyone who calls Pandora a Radio company doesn’t understand the space -- ignore them and move on. Netflix (NASDAQ:NFLX)investors had the same look in their eyes when I told them their is nothing unique about your company. You have no content, hence no real power. Its hard for investors to grasp “power paradigms” but in some cases it just takes a bit of common sense. The key to any business is what makes you unique and the control you have over your content or product. Netflix wasn’t unique, in any way. What made them powerful was...

Availability! You guessed it: First to the XBOX, first to the internet and first to your mailbox. But what is Netflix? It is a 100% content distribution company. Some see Netflix as a Sirius XM. A content distribution company. Not entirely true. They have a ton of unique content you can only find on Sirius XM. It is also a content mega store. Want CNBC, NFL, and Martha Stewart on one service? Look no further. Want to hear local traffic and Bloomberg radio without missing your favorite stock quotes? Simply record your Bloomberg show and listen to the traffic. Then go back and listen to your Bloomberg Finance show at your convenience. Can Pandora do that? Of course not. Because its not really a competitor of Sirius XM. Analysts pumping Pandora and brokers would love to convince you that it is competition, but the numbers say otherwise. Let’s look at total revenue from radio and how it breaks down.

At end of year 2010, there was a total of $18.8 billion in revenue generated by the radio industry. Although I do not include many of these companies in this space personally, Sirius XM has so I will include them here to humor them. Of that revenue, terrestrial radio produced $15 billion or 80% of it. Now that’s Sirius XM’s competition right there. Of that money, Sirius XM received $3 billion. All internet radio companies combined, excluding Spotify which was not in the United States yet, was only 5%, or less than $1 billion. So Sirius XM alone gross’s more than 3 times as much as all the internet radio companies combined. Who do you think record labels and performing artists like more? The 80% paying next to nothing in royalties, or Sirius XM paying 7% of their revenue? Even the pittance for a combined internet radio space doesn’t excite anyone. So who’s rooting for who here? Don’t discount where the content kings want their content to appear in the future. Part of a free business model with limited return, or a subscriber business model with consistent cash flow?

As for pay subscription service money for radio, Sirius XM is king. They receive 90% of all subscription money paid into the radio space. Of the total $3.1 billion estimated for end of year 2010, 2.8 billion of that was Sirius XM’s. So approximately $300 million left for all other services combined.

But you say, how much does each user generate for the radio companies involved. At the end of year 2009, Sirius XM generated $172 per subscriber and $72 a listener. Terrestrial radio generated $10 to $12 a listener and internet radio generated around $1.25 per user. If you were an advertiser, where would you pay more to advertise? Which of these user groups do you think has the highest percentage of disposable income? Sirius XM does of course. An Arbitron (NYSE:ARB) study done from 2010 clearly showed that. Age and income of the Sirius XM user is higher than those who listen to free music. It’s common sense. So can Pandora tap more free users? Of course they can. Can Sirius XM tap even more higher income users would prefer actual radio content over free? Of course they can. This isn’t an article to say if internet radio’s business models are sustainable. Although recent comments from the founder of Pandora seem to indicate he isn’t even bullish his own model. This quote from Tim Westergren is revealing:

One that is still fresh in my mind was the fight over royalty rates when we almost went out of business because the rates imposed by the copyright tribunal were astronomically high.

Our next great challenge is going to be tackling the licensing issues internationally.

Basically Pandora was out of business if those representing the royalty side, SoundExchange or whoever it happened to be, got what they wanted, seen to them as a fair deal for their rights. They settled on a temporary agreement that now puts revenue step and step with costs. As their revenue goes up so do their costs. As more users use the product, so do their costs. Once Sirius XM adds a subscriber, that cost is 100% done. Their system is already in use, and their total revenue is adjusted percentage wise, 7%, to pay the royalties on that added revenue. Also one difference; that money is paid by the consumer, not Sirius XM. Sirius XM passed along this fee to its customers and they paid it and the company still added over 1 million subscribers since it was instituted. Here is another quote from Westergren:

Pandora plays the music of over 90,000 artists. This translates into a substantially larger number of rights owners — the artists themselves, labels, publishers, etc.

Without a one-stop shop for licensing, it’s administratively difficult to enable the service. Where these centralized entities do exist, they have demanded royalty rates that are completely uneconomic. I would argue that in so doing, they are failing to serve their very constituents.

I would argue, uneconomical for who? So Pandora feels that royalty demands should fit into their model. That’s ludicrous. Could you imagine if a corporation called the IRS asked them to suspend their tax payments because they are ”unable to fit them into their model.” They would laugh at the company and hang up. That is what the Sound Exchange and other agencies representing the music performers/labels and songwriters should have told them. Never heard such illogical ranting in my life from a “CEO” of a company. Terrestrial radio business model relies on a basically free royalty situation. Artists and record labels have fought long and hard to break the NAB-controlled FCC and Congress on this issue. Without legal protection from the government, terrestrial radio’s business model becomes obsolete as well. The times of music labels and record companies needing terrestrial radio to promote their new music offerings are over. Sirius XM not only will promote your music, they will pay you more than anyone else for it, per dollar of revenue generated from that music. I sense a larger relationship between Sirius XM and record companies in the future. We should just call them music content originators really. Some analysts even see trickery in how Pandora reported their latest earnings. By delaying royalty payments and with cash from the IPO, they appear stronger then they really are. So Pandora, in my opinion, is in big trouble. I believe their model is unsustainable. According to Jim Edwards of BNET, the SEC has informed Pandora that their model is unsustainable. Seems like there is some agreement here from higher parties as well. Here is what the SEC stated:

In order to provide greater balance to your summary, highlight that:

You currently operate under a business plan strongly reliant on lobbied concessions and federal court and federal agency consent decrees and settlements, setting reduced royalty and licensing rates that expire in 2015 and that ordinary rates, not subject to such extraordinary measures, to which you may be subject upon the expiration of these exceptions make your current business plan unsustainable, as discussed in your risk factors on page 15 and 16;

So as you can see, some are some aren’t. One thing is true always since the .com explosion. Internet companies will come and go, and they usually are never bigger than when the media is pumping them. Yahoo (YHOO) has been around for decades now. They still struggle with growth. Ebay (NASDAQ:EBAY) has trouble growing. (NASDAQ:AMZN) is good. Google (NASDAQ:GOOG) is a search engine and Facebook is our social network. Can you name 10 websites that have stood the test of time outside of these for 10 years? I can’t either. Actually you couldn’t even include Facebook if you go back 10 years. Anyone remember Myspace? Exactly. At least no sites that generate significant profits and are exploding with growth potential still 10 years later. Why? Because in the end, forget the website or where you can access it, it ultimately comes down to unique service and content. Just because Pandora is heard in a car, doesn’t mean the driver is watching the ads scroll by, or they get better users. Geez, I hope not. Internet radio is unsafe then as well. If these ads turn to audible ads, then you are no better than what Sirius XM was created for; to avoid commercials and noisy interruptions in your day, and maximum variety. If I wanted to be blasted with ads and listen to the same songs over and over I’d just turn on my AM/FM radio and probably get better reception and no data charges to boot.

Terrestrial radio is becoming less powerful by the day as Clear Channel is struggling and other companies are selling off markets to local control. It’s all about the nationally syndicated shows now and the national advertising dollars. The evolution of any business is that way. Look at the cable and satellite TV industries. Local shows are practically extinct except for the local news now and a few day time TV shows run by individual networks. My local radio stations pick up a ton of national content now. Most talk stations run national shows now not local shows. This pulls them further out of the communities and ironically makes them less of a competitor to satellite radio due to its declining influence on the community itself. National syndicated shows are all over Sirius XM already and easily available. You don’t need to worry about if or when your local station manager will pick up this guy or that guy. Your one stop radio site is already available.

If internet radio appears to be growing, it probably is. In 2006 the OEM side was in its infancy. Penetration into the OEM market was a tiny 21%. The next wave of new car buyers, about every 5 year cycle, would not have been exposed to the product as of yet. Sirius XM is still expanding their exposure. By 2015 approximately 75 million cars will have a satellite radio in them. One difference. The two industries are not going after the same audience. Those who have no money for discretionary spending are internet radio listeners mostly. Those who can afford to pay for radio will. Those who can’t will find nice cheap options. So as you can see, there is an entire country still to expose to both sets of products. With added internet availability and access will come more exposure to their services. But it’s still free, it’s still not radio and it’s still not Sirius XM’s target customer base. Availability, OEM cars, wi fi, or whatever expands exposure to all these products. As Sirius XM customer base grows so could internet radio’s customer base. Anyone who is foolish enough to point out that growth in Spotify or Pandora means declining interest in satellite radio doesn’t understand this concept, has a poor grasp of the sector, and probably shouldn’t have an opinion on the subject.

Another problem now with internet radio is you can’t hear it anywhere you can’t hear Sirius XM. Period. Not one place, not one car, not one computer. Not one cell phone, iPad or iPod. If you can get online, you can access Sirius XM. If you have a satellite radio you will pick up the signal anywhere within the continental United States, parts of Canada, Mexico, and Alaska. Off the coast, in the desert, or on a river in the middle of nowhere, it doesn’t matter. So still Sirius XM has a greater coverage area. Sirius XM is still expanding their exposure with used car markets and new car buyers. Internet radio is as well. Keep in mind, Sirius XM has grown through the introduction of internet radio.

Still, free is free. It’s never been a business model that has been a game changer. Facebook has 500 million users worldwide, and they still don’t generate the revenue Sirius XM does with only 21 million subscribers. In the world of business models, subscriber ones are simply better than ad based free models. It takes an insane amount of users to even hint at big profits in this format. If terrestrial radio ever had to pay streaming rights on their station’s rebroadcasts over the internet, I Heart Radio would fail the next day. If Spotify, Rhapsody, and Pandora ever had to pay up for their real usage like satellite radio does, they would be out of business in short order. Basically any internet music company is a law away from extinction. As is they are struggling with a very small market share of money to divide up.

ITunes,, Rhapsody, Spotify, and Pandora all make money on the backs of artists and record labels who are catching on to what is really important, content. Netflix is starting to see that too. With Starz bolting, just wait until Sony (NYSE:SNE), EMI, or BMG pulls their rights from all internet radio stations for more money and control of content flow. When their libraries start shrinking you will see the last dying grasp of a chaotic industry that never should have existed. Record labels have failed their artists and industries allowing this to run rampant. Sirius XM is a record label company's greatest supporter. They pay more money a year than any online site combined. Sirius XM pays over $220 million a year for the rights to play its music selection. If Pandora had to pay that, they have more users why shouldn't they, you wouldn’t see them pumping that 90 million users, you would watch it drop to 5 million faster than you can blink. Their honesty would be forthcoming then. Well, we really don’t have that many users, it’s more like 5 million, not 90 million. Hilarious of course. Numbers are fun to play with aren’t they? Reality is this; Pandora generates around zero dollars in cash profit. Sirius XM is generating around $180 million a quarter and rising in profits. Sirius XM with cash on hand could buy out Pandora today. At least a majority stake. Why hasn’t Mel Kamarazin? Because he’s not stupid thats why. Do you think Pandora going to an IPO is a coincidence. No, it’s called getting venture capitalists their money back. Same reason Facebook sold some control. Hard to monetize a online business like Facebook. Forget Pandora. Pandora is near impossible to value. With no barrier to entry and no loyal fan base (any random music generator online would suffice if exposed) I don’t see Pandora or any internet music company competition for Sirius XM.

With the advent of internet radio, Sirius XM has grown from zero subscribers to over 21 million subscribers. Effect of internet radio to date: None. No effect shown. I will update this topic every year to make sure. Remember, internet radio was available for over 6 years before the very first Sirius XM subscriber even existed.

Disclosure: I am long SIRI.