2 Headwinds for Sirius XM Radio You Shouldn't Ignore

Sirius XM Radio  saw its stock price fall by a sizable margin in the past couple of months, as the company's majority shareholder, Liberty Media, backed off of plans to acquire the satellite radio provider. In terms of revenue and subscriber additions, Sirius remains healthy, and the company has high free cash flow and EBITDA margins. In spite of having a subscriber base of more than 25.56 million, the company faces major headwinds, including rising competition from internet players like Pandora , that can handily contribute to its decline. 

Rate increases
Sirius' music offering doesn't have commercials, but instead is acquired from artists and agencies for royalty fees. Sirius faces a lot of competition from other providers of audio entertainment for both listeners and advertisers in its select non-music channels.

The company's music royalty payments are significant and can drive up costs while compressing margins in the future. This problem can worsen if Sirius' churn rate increases dramatically from the current rate of 1.9%. 

Sirius doesn't break out royalty payment rates as a separate line item in its financial statements, but instead reports them along with revenue-share agreements. In 2013, the music royalty payments and revenue-share agreements made up 18% of the company's total subscription revenue. In the future, the company's payments for music content on satellite radio will increase by 50 basis points every year from 2013, when it paid 9% royalties on gross revenue, until 2017.

In addition, Sirius also serves customers on the Internet under My SXM and Sirius XM On Demand. Those offerings will also see payments increase within the next couple of years for music streamed over the Internet. A sharp increase in payments, along with a drop in cumulative subscribers, can be a headache for the company.

Competition from terrestrial and Internet radio
Increasingly, newer competitors are entering the audio entertainment market and magnifying the competitive playing field for Sirius. The company has been competing with terrestrial ad-supported free radio for a long time, and now major Internet players are stepping up their efforts to compete with Sirius and get a piece of the pie. 

Leading Internet radio service Pandora is surging ahead with growth in users, listening hours, and market share. In March 2014, Pandora saw its total users grow to 75.3 million, an 8% year-over-year increase. This increase in total listeners has translated into a 14% year-over-year increase to 1.71 billion listener hours in the month of March, both of which aren't exactly good signs for Sirius.

Pandora is already integrated across major auto makers in the U.S., and the company has begun playing audio ads on the in-dash infotainment systems of various cars. Clearly, more people playing Pandora in cars can translate into fewer paying subscribers for Sirius.

Also, Apple has seen good usage of its iTunes radio service. The iTunes radio service was originally laid out to boost digital music sales, which have been declining as consumers shift away from digital purchases to streaming options like Pandora and Spotify. Apple's large customer base can connect their Apple devices and use them in their cars like a makeshift infotainment system. Apple's music streaming offering is ad-supported, just like Pandora, and should lead to cannibalization of music downloads instead of growing music sales. 

The moat separating Sirius from Apple and Pandora is somewhat protected because the competitor offerings are ad-supported musical content, whereas Sirius provides commercial-free music and offers a larger variety of exclusive content including sports, popular talk shows, news, and comedy.

Going forward
In spite of competitive concerns and potential increases in expenses, Sirius remains a solid business with stellar revenue growth. Its subscription revenue is more stable compared to advertising revenue, which can be volatile. Sirius' growth in free cash flow, and its increasingly diversified revenue base, should aid in protecting the company against further competitive onslaughts. 

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The article 2 Headwinds for Sirius XM Radio You Shouldn't Ignore originally appeared on Fool.com.

Ishfaque Faruk owns shares of Sirius XM Radio. The Motley Fool recommends Apple and Pandora Media. The Motley Fool owns shares of Apple, Pandora Media, and Sirius XM Radio. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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