New York-based satellite radio broadcaster Sirius XM Holdings’ (Nasdaq: SIRI) US$3.5bn purchase of streaming music firm Pandora Media (NYSE: P) has dented the perception of the company’s merger-related earnings prospects.

SIRI said the deal, conducted as an all-stock transaction, is expected to fetch more than US$7bn in pro-forma revenue in 2018, as well as certain long-term growth opportunities, including an expanded footprint beyond vehicles into homes and other mobile areas.

The transaction follows SIRI’s US$480m strategic investment in P, which it completed in September 2017. At the closing of the stake purchase, SIRI’s management had already begun to migrate into its target’s ranks.

(Click on image to enlarge)

SIRI’s chair Gregory Maffei, CEO James Meyer and CFO David Frear were each named to P’s board, with Maffei named P’s chair.

Meyer said that through the merger, “there are significant opportunities to create value for both companies' stockholders by combining our complementary businesses. The addition of Pandora diversifies SiriusXM's revenue streams with the U.S.'s largest ad-supported audio offering, broadens our technical capabilities, and represents an exciting next step in our efforts to expand our reach out of the car even further.”

Meyer continued that by targeting investments, “we see significant opportunities to drive innovation that will accelerate growth beyond what would be available to the separate companies, and does so in a way that also benefits consumers, artists, and the broader content communities.”

Looking at growth

SIRI’s growth has been decent, and its debt levels have remained relatively stable.

At the end of June 2018, the company posted total long-term debt obligations of about US$6.44bn, down from more than US$6.74bn at the end of 2017. Furthermore, in the second quarter of 2018, SIRI generated a 6% year-on-year rise in revenue to US$1.4bn, with diluted earnings per share up almost 50% to US$0.06, and free cash flow up 17% to US$486m. 

However, the combination with P could hamper SIRI’s financial progress, as further details about the synergies gained through the transaction, as well as about the company’s related capital spending plans, remain murky. The fuzziness also apparently did not spur confidence among investors. 

SIRI’s stock had plummeted more than 10% after the news, culminating in almost 18% of losses from its 52-week high set in mid-June. The option adjusted spread on its outstanding bonds were also recently quoted 2bps wider at just north of 192bps, with its 5% August 2027s out 4bps at an OAS of more than 235bps.

Meanwhile, while Moody’s Investors Service said it does not anticipate the tie-up with P will affect Sirius XM Radio’s ‘Ba3’ credit rating, it has recently said the company’s credit profile has come under pressure.

Moody’s noted that the Copyright Royalty Board's (CRB) decision in mid-December 2017 to increase royalty rates had a negative impact on SIRI-owned Sirius XM Radio’s credit, affecting around US$8.25bn of rated debt.

Given the CRB’s decision, Sirius XM’s statutory royalty rate rose to 15.5% of its gross revenue, which includes payment to record labels and performing artists for sound recordings and public performances of their songs on its satellite radio service over a five-year period.

Ride-sharing

SIRI has also been pouring money into the connected-car space.

It paid US$115m for start-up Automatic in April 2017, for example, to bolster its position in the connected vehicle ecosystem with data collection and analytical tools.

SIRI claims to have agreements with “every major automaker” (OEMs) to offer satellite radio in their vehicles, which is how it says it acquires most of its subscribers. SIRI also said it obtains subscribers through marketing to owners and lessees of previously owned vehicles that include factory-installed satellite radios that do not currently subscribe to its services.

As of June 30, 2018, the company boasted around 33.5 million subscribers, of which self-pay and paid promotional subscribers comprised about 84% and 15.8%, respectively.

It appears SIRI is aiming to exploit P’s ad-supported audio model to bolster its marketing efforts, likely with an aim to capitalize on its investments in the connected-car space.

For its part, P’s ad-based, streaming radio is offered at no cost to its audience, or at US$5 per month without ads. For a US$10 monthly subscription, the listener receives ad-free streaming radio, as well as access to an on-demand library. It competes with the likes of Spotify (NYSE: SPOT), Slacker, as well as music services offered through Apple (AAPL), Amazon (AMZN) and Google’s (GOOG) YouTube, among others.

In the meantime, SIRI’s purchase of P is expected to close in the first quarter of 2019 and remains subject to approval by Pandora stockholders, as well as other customary closing conditions.

For now, both SIRI and P reiterated their forward earnings guidance.

For its full-year 2018 outlook, SIRI continues to estimate self-pay net subscribers of 1.15 million, revenue over US$5.7bn, adjusted EBITDA of roughly US$2.2bn, and free cash flow of about US$1.5bn. P said its third quarter of 2018 guidance continues to estimate revenue of US$390m to US$405m and adjusted EBITDA at a loss of between –US$25m and –US$10m.

Despite any concerns about the merger, shares of SIRI and P were each up intraday Wednesday, along with a broad lift in the S&P 500 (SPX).

SIRI was last quoted up just under 1.5% at US$182.55, P was up over 2.7% to US$6.44, and SPX was up 0.28% at US$2923.68, according to the IBKR Trader Workstation.