Sirius XM – Pandora’s box

Paying cash would open Pandora’s box. 

• Sirius XM has agreed to buy Pandora in a move the ensures Pandora’s long-term survival as well as gives Sirius XM an insurance policy should its existing business fail to survive the automotive transition to digital.
• Sirius XM will pay $3.5bn in shares to acquire Pandora whose existing shareholders will own 8.6% of the new entity which is expected to come into being in Q1 2019.
• I think that Sirius is buying Pandora because:
  • First, streaming: Pandora is an all streaming platform while Sirius XM is predominately a satellite radio broadcaster of premium content.
  • This means that if its broadcast moves all to streaming, it runs the risk of having no established presence to migrate its service towards.
  • Pandora also brings in an advertising offering and the largest digital audio advertising offering currently available.
  • Digital audio advertising is very much in its infancy but could end up being very important for audio content offerings that are monetised via advertising.
  • The problem that broadcasters face is that the vehicle is rapidly being digitised and the OEMs are not well prepared meaning that the outlook for their own infotainment offerings is very uncertain.
  • Broadcasting is a very profitable and cash generative business for Sirius XM which must be protected and given a route forward under all scenarios.
  • Bringing Pandora in-house gives Sirius XM an out if OEM infotainment offerings fail to engage users in the vehicle.
  • Second, Free user funnel: Sirius has 36m users that subscribe to its services and 23m on free trials.
  • This implies that its conversion rate from the free to paid tier is very poor.
  • Pandora has 71.4m MaU’s the vast majority of whom are advertising supported, free listeners.
  • Adding in these users to Sirius XM’s free trial users will create a much larger funnel through which Sirius XM hopes to grow its user base.
  • Third, new products: The combination of Sirius XM’s strong talk content offering and good profitability should enable investments to be made in future products.
  • These might include services like seamless listening from vehicle to phone as the user moves around, putting Pandora’s content over its satellite broadcast system and improving Pandora’s content by adding some of Sirius XM’s shows to the line-up.
  • This should create greater monetisation of offerings and synergies but both management’s declined to put a number on how big these synergies might be.
• A key aspect of this deal is the fact that Sirius XM is paying in shares.
• Sirius XM stated that it was paying shares in order to give Pandora share shareholders the ability to participate in long-term upside but this makes no sense at all.
• If Sirius XM pays in cash, then shareholders who want to participate in the merged entity can simply purchase Sirius XM stock with the cash they receive.
• I think that the real reason is risk.
• Sirius XM and Pandora shares have both performed very well lately and so expensive paper is being used to buy more expensive paper.
• Sirius XM already has $6.4bn long-term debt on its balance sheet of which $4.7bn is matched with intangible assets and goodwill making its financial position look already stretched.
• With only $250m in cash, Sirius XM is not really in a position to raise another $3.5bn in debt making equity as its only realistic option.
• Furthermore, this is a risky acquisition.
• Pandora has clearly has a fundamental problem with profitability as gross margins are declining due to being crippled with paying out 63% of its Q2 18 revenues in content royalties.
• I think that this a major reason why it has agreed to be acquired as the long-term future on its own looks pretty bleak.
• By contrast, Sirius paid out 22% of revenues in Q2 18 thanks to the vast majority of its content being listened to over satellite broadcast.
• I think it is clear from the tone of both companies that Sirius XM intends to preserve this business model for as long as it can as it has $6.4bn of debt to service, the interest alone of which is $180m per quarter.
• Hence, this acquisition is about mitigating future risk, giving Sirius XM a way to be relevant should the OEMs make a mess of their transition to digital.