Pandora also poses a challenge for its new parent: It lost 5.1 million free listeners over the last four quarters, and as Spotify, YouTube and Amazon pour resources into new products and features, its funnel of free users that can be converted into paid subscribers is shrinking. There's no guarantee that Drake and U2 can stop the listener exodus.
Given what's known about streaming economics, satellite radio is probably more profitable than the entire music streaming business. SiriusXM has told investors it expects 2019 earnings before interest, taxes, depreciation and amortization (EBITDA) of around $2.4 billion, and free cash flow of approximately $1.625 billion. Even with the cost of maintaining four satellites in geo-synchronous orbit, SiriusXM comes out ahead. Pandora caught a financial lifeline and now its competitive advantage is its owner.
There are stark differences between SiriusXM and Spotify, a streaming-only company that has far surpassed Pandora's listenership. The two companies had about the same third-quarter revenue ($2 billion for SiriusXM, $1.9 billion for Spotify), but SiriusXM has enviable margins: Spotify keeps about 30% of its revenue and pays the rest to rights holders; after paying royalties and programming costs, SiriusXM keeps 70%. Even with the addition of Pandora's weaker financial standing, the satellite radio-based model has better margins and turns a net profit.
The two platforms don't overlap, but SiriusXM has said cost synergies will reach $75 million annually by the end of 2019, 50% more than the $50 million estimated when the merger was announced. But the tantalizing benefit is the addition of a free service to a paid one and vice versa.
Meyer described the hybrid company as a "funnel" in which Pandora's free listeners at SiriusXM are drawn to become satellite radio subscribers — i.e., the freemium model. "As we get people into that free funnel, you can expect we will promote the value of our subscription," he said during the earnings call. The funnel is a financially attractive tool. Marketing to existing listeners is practically free for a company that spent $118.4 million to acquire satellite radio customers in 2018.
One of SiriusXM's challenges will be that its funnel is getting narrower. Since the acquisition was announced in September 2018, Pandora's free listeners decreased 8.3% to 56.8 million. Upon the acquisition's close in February, SiriusXM's monthly footprint jumped from about 30 million to nearly 100 million, including Pandora's free/subscription listeners. But with free users fleeing, SiriusXM has fewer opportunities to upsell satellite radio.
The SiriusXM-Pandora deal makes sense if its low-margin streaming business isn't a drag on the income statement. "Pandora will be EBITDA-positive in the second half of the year," said Meyer on the call. SiriusXM's financial statements don't break out components of Pandora's contributions to EBITDA. But the pro forma statements — calculated as if the acquisition took place Jan. 1, 2018, to allow for year-to-year comparisons — show improvements in the first nine months of 2019. The combined company's revenue was up 11.2% to $1.25 billion, while gross margin, the percent of revenue kept after paying revenue-related expenses such as royalties, grew 38.1% to $435 million.
Aside from the financial benefits, there are the optics: Size definitely matters in the music business.
"Music superstars continue to acknowledge the power of our platform, and in a competitive audio world that matters," said Meyer on the call, adding that he spent 10 years telling the equipment manufacturers "how crappy the Pandora algorithm is." But what impressed him was the technology. With Pandora, SiriusXM has a safety net for catching lapsed satellite subscribers. "Our goal should be to never lose a listener," said Meyer. So, rather than lose a satellite subscriber or free trial user, SiriusXM can guide people to ad-supported Pandora. Research by MusicWatch found 58% of Americans listened to music on broadcast radio in the previous week. But just 44% of 18- to 24-year-olds and 49% of 13- to 17-year-olds did so. And 86% of 13- to 17-year-olds streamed music the previous week.
With the acquisition behind him, Meyer said, perhaps for effect, that he "spent 12 years lying awake at night worrying about Pandora's place in new vehicle production." But SiriusXM executives and investors can sleep well... for a quarter or two. Market changes will soon require their alertness.
This article originally appeared in the Dec. 14 issue of Billboard.