Sirius XM (NASDAQ:SIRI), which has significantly expanded by utilizing automotive channel and partnering with car makers such as Ford (NYSE:F) and GM (NYSE:GM), recently filed a complaint against SoundExchange, Inc. and American Association of Independent Music.  Sirius XM wants to secure direct licenses from the music labels and artists while these organization act as an intermediary and set up royalty rates. Let’s take a look below what this lawsuit is about and what the motivation of Sirius XM behind this charge is.
Sirius XM Wants Direct Licenses To Improve Service
Sirius XM wants to cut out the mediating organizations in order to secure audio licenses directly from the labels and artists. This will give the company greater flexibility, a price advantage and faster processing. Sirius XM argues that SoundExchange currently deducts its administrative fee from the royalties that the companies pay. Sirius XM can eliminate this, thus benefiting the artists. Furthermore, as Spencer Osborne argues, Sirius XM could be looking at personalization of its radio service with this lawsuit as direct access to record labels could help it personalize and improve its service better. 
What SoundExchange Thinks
SoundExchange believes that it is protecting the artists and copyright owners who might not get favorable terms if Sirius XM is allowed to directly negotiate with them.  The organization believes that current royalty rates are below the market standards and plans to increase them for Sirius XM. This increase, if it happens, is going to be especially high for 2013 and beyond.
Royalty Rate Increment Is Unacceptable To Sirius XM
SoundExchange is seeking an increase in the royalty rate from 7.5% of the gross revenue in 2011 to 13% of the gross revenue in 2013.  This is a very significant increase in Sirius XM’s cost and the company believes that this is unreasonable. Sirius XM argues that market rate is around 5% to 7% of the defined revenue.  It is unclear what ‘defined revenue’ means but it can not be more than the gross revenue. This implies that Sirius XM believes that it is paying much more than it should. This is a huge jump and can have significant impact on Sirius XM’s value.
Potential Impact On Stock
The relevant cost driver in our models that gets affected as a result of this legal battle is Sirius XM’s revenue share and royalty cost. Given the subscription and advertising revenues of close to $2.7 billion in 2011 and 7.5% royalty rate, we estimate that Sirius XM paid close to $200 million in royalty fee while total royalty & revenue share cost stood at $471 million.
If the royalty rate rises to 13% in 2013, Sirius XM will be paying close to $440 million in royalty fee alone. If we assume that revenue sharing costs (as % of revenues) will remain similar as in 2011 and royalty rate will rise to 13% in 2013, Sirius XM’s total revenue share and royalty cost as proportion of revenue will increase to about 25% in 2013 as opposed to our current flat forecast. This can lead to a downside of about 20% to our current price estimate. To counter this, Sirius XM will have to raise prices which may not be well received by its subscribers.
Our price estimate for Sirius XM stands at $2.26, implying a discount of less than 5% to the market price.Notes:
- SiriusXM Files Antitrust Claims Against SoundExchange and a Record Industry Trade Association, Sirius XM Press Release, Mar 27 2012 [↩] [↩]
- Sirius XM Draws A Line In The Sand On Royalties, SeekingAlpha, Mar 30 2012 [↩]
- October 2011: SoundExchange Statement on Sirius XM Direct Licenses and the Statutory License, soundexchange.com [↩]
- SiriusXM Files Lawsuit Against SoundExchange and A2IM, Alleging Licensing Interference, billboard.biz, March 28 2012 [↩]