Sirius XM: Why A Rise In Revenue Share And Royalties Will Be Slow

by Trefis Team
Sirius XM Radio
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Sirius XM‘s (NASDAQ:SIRI) “revenue share and royalties” includes distribution and content provider revenue share, residuals and broadcast and web streaming royalties. Residuals are monthly fees paid based upon the number of SIRIUS and XM radio subscriptions purchased from retailers. Advertising revenue share is recorded to revenue share and royalties in the period the advertising is broadcast. This expense is expressed as a percentage of subscription revenues.

Revenue share and royalties as a percentage of subscription revenues has increased gradually over the past few years, amounting to 22.8% in 2014. This increase was primarily driven by growing royalty rates as the company kept its subscription pricing constant. Going forward, we expect these costs to increase, but at a slower pace as the company looks to propel its topline growth with a push into the used car market and retain control over the royalties it pays.

Our current price estimate for the company stands at $3.78, which is about 5% below the current market price.

See our complete analysis for Sirius XM

Significant Rise In Royalties Unlikely

Under the terms of the Copyright Royalty Board’s decision, Sirius XM paid royalties of 6.5%, 7.0%, 7.5% and 8%, of gross revenues, subject to certain exclusions, for years 2009, 2010, 2011 and 2012. In 2012, SoundExchange, an independent body serving as a bridge between radio companies and songwriters and labels, proposed a significant increase  in royalties for Sirius XM.

According to the proposal, SoundExchange wanted Sirius XM to pay 12% of its revenues as royalties for 2013, ending at 20% in 2017. However, the Copyright Royalty Board rejected this proposal and kept Sirius XM’s royalty rate increase at the historic levels. The company paid 9% in royalties in 2013 and 9.5% in 2014. For the next three years, the rates are set at 10%, 10.5% and 11% respectively. [1] Since there isn’t any significant rise in royalty rates in the near future, Sirius XM has a good opportunity to sell more subscription and optimize its residuals and web streaming expenses.

Interestingly, directly licensed sound recordings were excluded from the Copyright Royalty Board’s decision. This gives Sirius XM an opportunity to strike deals with several artists, songwriters and labels, at a price that is favorable for the company, thus allowing it to manage its overall revenue share and royalties in a better manner.

Sirius XM Can Still Sell Plenty Of Subscriptions

New vehicle sales in the U.S. hit 16.5 million in 2014 and the figure is projected to reach 17 million this year. [2] Even with a stable new vehicle penetration rate, Sirius XM can expect 3%-3.5% growth in subscribers this year through new vehicle market. However, its growth will be stronger through the used car market, given that more than 15,000 used car dealers are now offering Sirius XM trials.

Management stated during the company’s Q4 2014 earnings call that it expects satellite enabled cars count to increase to 100 million by the end of 2017, up from 70 million in 2014. Also, the company recently launched a service continuity program, that allows car users to easily move their subscriptions when they buy a new vehicle. This is likely to have a positive impact on Sirius XM’s retention rate. With higher number of subscribers, Sirius XM stands a chance of growing its revenues relative to its web streaming royalties, that are paid on per performance basis.

Renewed Contract Will Help

Sirius XM reworked its contract with GM in 2009 and it now has a contract until 2020. In Q1 of 2009, before the GM contract was reworked, nearly 2.9% of total revenues went to pay for GM revenue sharing agreements. In Q2-2009, Q3-2009,Q4-2009, Q1-2010 this figure was 2.2%,2.3%,1.8% and 1.3%, respectively, of the total revenues. This figure is expected to be a the same level or lower for the years through to 2020, clearly implying that Sirius XM was able to bend the contract in its favor. It also indicates that the company has a strong negotiating power when it comes to striking deals with automakers. It can rework similar contracts with other automakers as well, that can help it reduce revenue sharing expenses.

Downside Scenario

Revenue share and royalties as percentage of subscription revenues stood at 22.8% in 2014 and we expect it to rise gradually to 23.5% over the next five-six years. However, if this figure reaches 26% instead, driven by a rise in Internet radio royalty rates post 2015 and revision in satellite royalty rates after 2017, there can be more than 5% downside to our price estimate for Sirius XM.

However, we do not believe that Internet radio royalty rates for Sirius XM are going to increase rapidly since it already pays rates that the music industry should be comfortable with. For instance, SoundExchange wants Pandora Media (NSYE:P) to pay royalties at 0.25 cents per performance for 2016, but Sirius XM’s rates for 2015 are already set at 0.24 cents. The satellite radio company’s web streaming royalty rates have been increasing at the rate of 0.01 cents every year and if they increase by a similar amount in 2016 and beyond as well, it will be paying royalties at a rate acceptable to the music industry. However, there can be a significant revision in satellite radio royalty rates post 2017, as SoundExchange has already tried to convince the Copyright Royalty Board for the same once. It may come forth with a similar proposal in the future as well.

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  1. Full Text of Copyright Board Decision on Sirius XM and Music Choice Royalties, Broadcast Law Blog, Jan 4 2013 []
  2. Analyst forecasts 17 million U.S. sales in 2015, 20 million in 2018, Autonews, Jan 14 2015 []
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