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SiriusXM’s Solid Quarter Shows Benefits of the Subscription Model: Analysis Plus 5 Burning Questions

SiriusXM’s second quarter showed the stark contrast between subscription and advertising-supported businesses during the pandemic. CEO Jim Meyer emphasized this point during Thursday’s earnings call by saying “business models matter, and our business model is very resilient.”

Satellite radio and streaming subscriptions survived a 32.7% decline in Q2 G.D.P., a record spike in unemployment and a 48% decline in April auto sales (and smaller declines in May and June). SiriusXM’s self-pay subscribers rose by 264,000 to 30.3 million; the number of paid, promotional subscriptions — discounted rate, but effective at acquiring new customers — decreased 780,000 from 4.7 million to 3.94 million. Pandora’s subscription business was stable with 41,000 additional subscribers, and a $3 million drop in revenue. But the other side of SiriusXM’s business buckled along with the economy.

Through no fault of its own, Pandora’s advertising revenue dropped 31% from $358 million in Q2 2019 to $236 million last quarter; the sequential decline from Q1 to Q2 was 17.2%. Pandora’s advertising deficit improved as time passed, however: after year-over-year declines of 41% and 36% in April and May, respectively, June advertising was down 18% (Spotify’s ad revenue followed a similar April-to-May trend).

Because advertising can ebb and flow, a major slowdown can upend the math that underpins an ad-supported Internet radio service. Pandora pays royalties, for the most part, at a fixed amount per stream regardless of the revenue generated by the streams’ advertising. So, if listening hours remain steady from one period to the next, Pandora’s royalties obligations are also steady — regardless of any change in advertising revenue.

By Billboard’s calculation, from Q1 to Q2, Pandora’s advertising royalties declined 3.6% ($137 million to $132 million) while advertising revenue fell 12.4% ($241 million to $211 million). As a result, for Pandora’s advertising service, royalties as a percent of advertising revenue grew from 49.5% in Q2 2019 to an untenable 64.7% in Q2 2010. Pandora’s “freemium” business model simply doesn’t work when the numbers go backwards like this.

While the economics behind music subscriptions are notoriously difficult — services pay 70% of premium service revenue to rights holders — the subscription model has proven to be relatively pandemic-proof. Pandora’s subscription services — Plus and Premium — added 41,000 subscribers as the subscriptions revenue declined $3 million from $128 million to $125 million. Similarly, Spotify’s subscriptions grew 6.2% and advertising dropped 11.5% from Q1 to Q2 even though the number of free listeners increased 4.3%.

For its subscription service, Pandora pays rights owners a share of subscription revenue royalties under a standard licensing agreement. If subscription revenue falls, Pandora’s royalties obligation falls at roughly the same rate. Likewise, subscriber growth brings a commensurate, predictable increase in subscription royalties. Opinions may differ on the fairness of the subscription business model, but if subscribers don’t leave a service during a recession, services and rights holders benefit from the steady, recurring revenue.

In the end, the subscription model allows SiriusXM to offer a bundle of content — executives repeatedly talked about bundling during the earnings call. Over two decades, SiriusXM has found that consumers react to a bundle of diverse programming and well-known brands, from NFL games to branded artist radio stations (Bruce Springsteen, Tom Petty, U2 etc.). Meyer brought up an interesting rule that guides how the company bundles content: “Customers pay for what they think they listen to, not necessarily entirely [for] what they do listen to. They pay for what their perceived value is for the service.”

With subscriptions set to grow again in 2020, liquidity will not be a problem if the COVID pandemic spills into 2021. SiriusXM has an untouched, $1.75-billion credit facility and cash and cash equivalents of $278 million after deducting its current debt maturities. Plus, it generated $503 million in free cash flow in Q2 alone. SiriusXM executives said the company has the capacity to continue repurchasing shares, paying dividends, funding any satellite needs and making acquisitions.



5 Questions Following SiriusXM and Pandora’s Earnings:

Q1: How are record labels and publishers protected from swings in SiriusXM revenue?
Rights owners receive a share of SiriusXM’s music-related revenue; only for some streams on its web app does the company pay a fixed, per-play royalty.

Q2: Is SiriusXM going to lose subscribers in 2020?
No, probably not. The company has forecast 500,000 net new subscribers — meaning net of churn — this year. At the end of Q1 it pulled its guidance due to uncertainty from COVID. By providing guidance once again, SiriusXM signals it has enough certainty to share its forecast with investors.

Q3: Did COVID increase SiriusXM’s churn in Q2?
No, monthly churn actually dropped to 1.6% from 1.8% in Q1. “we’re sort of stunned at the very low level of non-pay churn,” said CFO David Frear. “It’s something we never would have guessed going into an economically sensitive period.”

Q4: Is Howard Stern going to re-up with SiriusXM when his five-year contract expires at the end of 2020?
To be determined. “I’ve been clear: I want Howard stern to work at SiriusXM for as long as Howard Stern wants to work,” said Meyer, reiterating comments he made during the Q1 earnings call on April 28. “I’ve engaged with Howard’s team — we began those conversations again late last year….we’re reengaged in those conversations right now.”

Q5: Why did SiriusXM acquire Stitcher and Simplecast?
SiriusXM is building its podcast business just as Spotify and iHeartMedia expanded into podcasting and original programming. Stitcher is a podcast app that aggregates other podcasts and has a few originals such as “Freakonomics.” Simplecast is a podcast distributor just as TuneCore is a music distributor. Spotify has a similar strategy of aggregating podcasts, distributing podcast content (through its Anchor app) and producing original content (mainly through its acquisitions of The Ringer, Gimlet Media and Parcast). iHeartMedia also acts as a podcast aggregator and produces original content.

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