Analysts are busy getting reports out on satellite radio equities today, and while the merger is the news everyone is waiting on, the Copyright Royalty Board decision announced yesterday seems to be the short term center of attention.
The reaction to the rates seems to be a mixed bag. Investors should note however that the announced cap of the rate is substantially lower than 23% that Sound Exchange was initially seeking. This news gives stability to an issue that has been overhanging these equities all year, and now makes long term projections possible with a bit more certainty.
EXCERPTS OF REPORTS
Deutsche Bank - James Dix
See Copyright Royalty Board as positive and reaffirm Buy ratings
We view favorably the decision of the CRB on music royalties.
CRB ruling appears better than we had forecast
XM announced today that the Copyright Royalty Board delivered its decision in the proceeding between the satellite radio companies and the music recording industry. Sirius' CFO David Frear discussed the ruling at a competitor conference. Under the ruling the satellite radio operators will pay a performance license rate of 6.0% of the revenue subject to the fees for2007 and 2008, 6.5% for 2009, 7.0% for 2010, 7.5% for 2011 and 8.0% for2012. Revenue subject to royalty fees includes subscription revenue and advertising revenue from channels other than those use music only incidentally.
Estimate savings of roughly 4% of revenue in 2008
For Sirius, for example, using our estimates of subscription revenue as a proxy for the revenue subject to the fees, we estimate that the new CRB rates could result in 2008 annual royalty expense roughly $50m per year lower than we currently forecast. Our current model assumes total music royalties of 7.5% of total revenue for 2007 and 12.5% of total revenue for 2008 onward. We assume that total music royalties would be the CRB royalty plus roughly 2.5% of revenue for the other royalties.
Reaffirm Buy ratings and $4 TP for SIRI and $17 TP for XMSR
We estimate that the new CRB rates could result in 5-10% valuation upside to our current models. We reaffirm our Buy ratings on both companies, as plays on the economical growth of satellite radio in US vehicles with potential merger upside. Risks include adverse regulatory trends (including nomerger approval), competing technologies, rising costs, and liquidity.
Stifel - Kit Springs - Note On XMSR
Copyright royalty board issued new rates for performance royalties(Sound Exchange) that were higher than expected:
Essentially,performers will receive significant increases from 3.5% of XMSR's adjusted gross revenues over the past 5 years to 6% in 2008 and 8% by 2012 - that's a 450 basis point increase or more than double in 2012, the terminal year of our models. This estimate applies to about 80% of revenues, by our estimates, and thus equates to about a 360 basis point hit to our margins. This change alone lowered our DCF by $1.25
In our view, this potentially sets a bad precedent for publishing royalties (SESAP, ASCAP, BMI), which may be renegotiated over the next couple years.
In addition to performance rates set yesterday, XMSR also pays the writers / publishers of songs about 3.5% of adjusted revenues, by our estimates. We believe publishers are set to renegotiate over the next year or two depending on the agency. Since publishers received an equal amount before, it seems logical they will seek similar new rates to performers. Publishers chances may be somewhat diminished by the fact terrestrial radio pays about 3%. We are now assuming a higher royalty rate for publishers of 6.5% in 2012 - in between performers receive and what terrestrial pays. This change lowered our DCF by $0.75.
We are thus lowering margins significantly particularly in our terminal year:
We are lowering 2012 EBITDA margins by about 350 basis points to19%. Some of the higher percentages are offset by new disclosure that the percentages do not apply to about 20% of revenues (we previously based percentages on total revenues).
Lowering to Hold as risk / reward is less compelling:
Due to higher than expected royalties, we are lowering our stand-alone fair value estimate from $13.50 to $11.50. We see potential upside to$19.50 in the event of a successful merger with SIRI, which we believe offers $4.8B of present value of synergies. We continue to see a 55%+ chance of DOJ approval.
Stifel - Kit Springs - On SIRI
Copyright royalty board issued new rates for performance royalties(Sound Exchange) that were higher than expected:
Essentially,performers received significant increases from 3.5% of SIRI's adjusted gross revenues over the past 5 years to 6% in 2008 and 8% by 2012 -that's a 450 basis point increase or more than double in 2012, the terminal year of our models. This estimate applies to about 80% of revenues and thus equates to about a 360 basis point hit to our 2012 margins.
In our view, this potentially sets a bad precedent for publishingroyalties (SESAP, ASCAP, BMI), which may be renegotiated over thenext couple years.
In addition to performance rates set yesterday, SIRI also pays the writers / publishers of songs about 3.5% of adjusted revenues. We believe publishers are set to renegotiate over the next year or two depending on the agency. Since publishers received an equal amount before, it seems logical they will seek similar new rates to performers. Publishers chances may be somewhat diminished by the fact competitor terrestrial radio pays about 3%. We are now assuming a higher royalty rate for publishers of 6.5% in 2012 - in between what performers receive and what terrestrial pays.
We are thus lowering margins significantly particularly in our terminal year: We are lowering 2012 EBITDA from $800MM to $636MM. Some of the higher percentages are offset by new disclosure that the percentages do not apply to about 20% of revenues (we previously based percentages on total revenue) and recently announced higher penetration by Ford.
Maintaining Buy but lowering target price by $0.50 and stand-alone target by $1.00 :
Due to higher than expected royalties, we are lowering our stand-alone target from $4.75 to $3.75, based on a 5-year DCF. Somewhat offsetting this, our target now gives SIRI credit for $0.55 of option value for a possible merger with XMSR - which we estimate at 55%+ probability
Utendahl - Alden Mahabir
New Royalty Rates Higher Than We Expected, Though Removes An Industry Overhang
CRB reaches a decision on royalty rates, ending Satellite Radio’s year long battle with SoundExchange.
On December 3, 2007, the Copyright Royalty Board (CRB) issued its ruling on performance license rates that were to be paid by Sirius and XM for the six year period starting January 2007 and ending December 2012. Based on the ruling, the satellite radio operators are set to pay a performance royalty rate, primarily on gross subscription revenue, of6.0% in 2007 and 2008, 6.5% in 2009, 7.0% in 2010, 7.5% in 2011 and 8.0% in 2012. Although neither company provided specific details as to what current royalty rates were, we believe that the companies were paying roughly 4.5%-5.0% for overall royalties, with the SoundExchange component being 2.0%-3.0% and the remainder going to music publishers. While the new rates are higher than what both companies were paying, it is lower than the 8% ramping to 23% that SoundExchange, the organization representing the record labels, was proposing to the CRB. Because the new rates are retroactive for 2007, we believe that both companies could face a charge in the neighborhood of $20-$25 million.
Although the new rates are better than some feared, it was higher than we anticipated.
We had forecasted overall royalty rates for both companies to be roughly 7% of subscription revenue for 2008 and beyond, which implied our SoundExchange component to be about 4.5%,assuming 2.5% for music publishers. Based on the new performance license rates, and continuing to assume 2.5% for music publishers, overall royalty rates should range from 8.5% in 2007 ramping to 10.5% by 2012. We believe most analysts were expecting overall royalty rates to range between 7%-10%.
While we view the new royalty rates to be incrementally negative to fundamentals, it does remove an industry overhang.
Many in the market had feared that the CRB’s ruling would be far more costly, especially if they had ruled in line with SoundExchange’s proposal. While the new rates will clearly cause some value erosion in our models, as we may have been overly optimistic, we believe the consensus market view could be neutral.
Maintaining our OVER-WEIGHT rating on SIRI shares and our EQUAL-WEIGHT rating on XMSR shares.
At this time, we are not adjusting our estimates or our price target for Sirius or XM. However, we will be reevaluation our models for both companies and providing an update in the near future.
Wedbush - William Kidd
Music Royalty Settlement Impacts Earnings and Valuation, But it Could Have Been Worse… Lowering Price Targets on SIRI and XMSR
• Arbitration process comes to a close, ending a longstanding royalty dispute between satellite radio providers and recording companies over music royalties. SoundExchange, a collective representing major music recording companies,had been arguing before the Copyright Royalty Board (CRB), as part of an arbitration process, for a rate structure that starts at 10% and progresses to 23% of revenue. The SoundExchange proposal differed greatly with our rate satellite radio company expectations, creating considerable risk. Under the terms of yesterday’s CRB ruling, which was announced during the later part of yesterday’s trading hours, the satellite radio providers will pay a performance license rate of 6.0% of those gross revenues subject to the fees for 2007 and 2008, 6.5% for 2009, 7.0% for 2010, 7.5% for 2011 and 8.0% for 2012.
• Considering how high royalty expenses could have been set, we believe the slightly positive market reaction to yesterday’s ruling was reasonable. . . We believe that consensus adjustments to the CRB rates range from 2.5% to 3.5%. We note that the market was bracing potentially for a far worse decision given that the SoundExchange proposal representeda roughly20% rate increase.
• . . . however, since even a positive resolution still represents notably higher royalty costs, don’t be surprised that the new rate structure negatively impacts our XM and Sirius EPS estimates and valuation. Yesterday’s ruling sets the new rate (which caps out at 8% in 2012) is a little higher than our expected 7% total royalty rate. To account for such other royalty payments to organizations like BMI, SESAC, and ASCAP, we forecast a royalty rate that is 300 basis points higher than the8% CRB cap. For perspective on the impact to our long-term Sirius/XM estimates, we believe the ruling represents more than$100 million in additional royalty expenses per year by 2012 for each company. The higher expense level negatively impacts our respective Sirius/XM DCF valuations to the tune of roughly $800 million.
• Based on the resulting royalty related estimate revisions, we are lowering SIRI price target to $3.50 from $4.00(assuming no merger) and our post-merger trading range (assuming the merger’s approved) to$4.50 from $4.50 to $5.00. Although we remain negative on the likelihood of a positive regulatory decision on the merger, we believe Sirius continues to be a good risk-adjusted play on the merger. Even without a merger, we believe Sirius is attractive, though the royalty decision did erode some of the company’s potential upside. For more detail on the earnings impact from the CRB decision, please refer to exhibits 1 and 2 for our revised annual and quarterly EPS estimates. Exhibit 4 represents our revised SIRI DCF valuation.
• As a result of essentially equivalent royalty adjustments to XM, we are lowering our XMSR price target to $9 from $12(assuming no merger), and our post-merger trading range (assuming the merger’s approved) to$18 from $20 to $21.We continue to believe that XMSR is an overly aggressive play on the merger decision and should be avoided. For more detail on the earnings impact from the CRB decision, please refer to exhibits 1 and 3 for our revised annual and quarterly EPS estimates. Exhibit 5 represents our revised XMSR DCF valuation.
• Risks to attainment of our Sirius and XM share price targets include shortfalls in subscriber growth; increased competition whether from XM; AM/FM radio, HD Radio, or streaming-media services; new/increased government regulation; a prolonged and/or failed merger attempt; an inability to renew key content and OEM contracts; and satellite anomalies.
History of Music Royalty Dispute Sirius and XM have been jointly before a Copyright Royalty Board Arbitration vs. SoundExchange, a collective operated on behalf of owners of copyrighted recordings such as the major record labels. Per company filings, the satellite radio operators had proposed a rate of 0.88% of each of their adjusted gross revenues for this statutory license. However, SoundExchange, filed a direct case proposing a rate increasing from 10% of adjusted gross revenues for the first year of the license increasing each year to over 23% during the final year of the license term. We note that satellite radio companies have already successfully negotiated agreements with the major music publishing organizations (ASCAP and BMI) at a rate much closer to their proposal than the SoundExchange proposal. Given the established market value of song rights, reflected in agreements such as radio station royalties, we thought it far more probable that the satellite radio providers largely prevail in this arbitration. In total, we estimated music royalties to all organizations at about 7% of total revenues, with major entities getting somewhere between 1%-1.5% each. The Decision On December 3, Copyright Royalty Board (CRB) set the royalty rate payable by Sirius and XM for the performance of sound recordings.
The Implications… Lowering Estimates on SIRI and XMSR The new rate is a little higher than our expected 7% total royalty rate considering that there are other royalty fees not captured in the rates specified above. To account for such other royalty fees from BMI, SESAC, and ASCAP, we adjust the rates above by 3%. We believe that consensus adjustments to the CRB rates range from 2.5% to 3.5%. We note that as the market was expecting a far worse decision given the proposed 20% rate, SIRI and XMSR seemed little affected by the decision in yesterday’s trading.
Position - Long Sirius, XM