Pandora Should Push For Subscriptions Based on Sirius XM’s Success

Although both Sirius XM (NASDAQ:SIRI) and Pandora (NYSE:P) are radio services, they operate in different spaces and have several key distinctions in terms of their business model and the medium of delivery. Sirius XM is a satellite based radio service catering primarily to vehicle owners. On the other hand, Pandora is an Internet radio service with presence across a variety of mobile devices as well as in-car systems. While Sirius XM derives the bulk of its revenue from subscriptions and is highly profitable, Pandora is reliant on advertising and is still making losses.

Needless to say, Pandora’s stock has been more volatile in recent quarters. Comparing the average revenue per user (ARPU), it becomes clear that Sirius XM has done much better in terms of monetizing its user base. This is one of the reasons why its business is more stable and operating cash flow has shown consistent growth. We believe that Pandora should make efforts to promote its own subscription service. In an event where 30% of its active users become subscribers, the company can double ARPU.

Our price estimate for Sirius XM stands at $3.45, implying a discount of more than 5% to the market price.

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Staggering Difference Between Sirius XM and Pandora’s ARPU

We estimate that Sirius XM’s annual subscription revenue per user currently stands at $134, with total annual revenue per user approaching $155. In comparison, Pandora’s annual advertising revenue per active user is just around $8, with total annual revenue per user slightly north of $9.40. This is a staggering difference as Sirius XM is charging a lot more to its subscribers. So why are they paying for it? The reason lies in the content quality that the company offers. Sirius XM is able to afford some unique content and talk show hosts that Pandora can’t because the former has room to do so due to its healthy ARPU and margins. Pandora too can do something similar if it can make a substantial improvement in its profitability. To achieve this, it may need to promote its subscription service alongside improving its mobile ad monetization. Currently the company has less than 4 million subscribers in comparison to more than 70 million active users. There is a lot of room for growth provided the right focus. The subscription ARPU is close to $36, substantially more than advertising ARPU.

Sirius XM’s High ARPU Is Aiding Strong Margin Growth

Sirius XM’s EBITDA margin (earnings before interest, taxes, depreciation and amortization) has grown substantially over the last few years driven by revenue growth and controlled expenses. Revenues have increased primarily due to subscriber growth and higher average revenue per subscriber. Besides capitalizing on the U.S. automotive market’s growth, the company has successfully tapped into the used vehicle market with an increasing number of pre-owned vehicle dealer partnerships. The average revenue per subscriber has grown due to price increases, and more subscribers are opting for Internet add-ons. It appears that the economies of scale are kicking in due to growing ARPU and aiding the company’s margin expansion. Several key cost components including subscriber acquisitions costs, general & administrative costs, marketing costs and billing costs have come down as a proportion of revenues.

Sirius XM’s adjusted EBITDA margin jumped from 1.9% in 2008 to about 35.3% in 2012. We further expect this figure to reach close to 45% by the end of our forecast period. If we look at other media and telecom companies, we conclude that Sirius XM is on track to become one of the highest margin businesses in this industry. Comcast’s EBITDA margin currently stands at just under 42%, and other media & telecom companies such as Time Warner Cable, Disney, Time Warner, Pandora, Dish Network etc., have lower margins.

Our price estimate for Sirius XM stands at $3.45, implying a discount of more than 5% to the market price.

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