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Sirius XM Royalty Costs Won't Spike, or Its Stock


Shares of Sirius XM (NASDAQ:SIRI) surged roughly 7% in late trading on Friday after the music industry's Copyright Royalty Board issued a smaller than expected judgment on music royalty costs for the satellite radio giant.

However, Friday's share gains may be overdone, according to an industry analyst. Sirius XM won't see its music royalty costs spike, but that wasn't justification for the late Friday stock surge, Evercore Partners analyst Bryan Kraft wrote in a note to clients.

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Near the market close on Friday, the CRB said that it will increase the rate it charges Sirius XM to broadcast music on its premium satellite radio network. In 2013, the rate will rise to 9% of Sirius XM's total revenue from 8% in 2012, and that rate will increase by 50 basis points per year through 2017, when royalty rates will hit 11% of revenue.

According to Evercore's Kraft, the rate increase was larger than expected, but the decision was a positive for Sirius XM's stock given the gradual approach to those increases.

"We view the outcome as positive for the company and the stock because: (1) the increases in the rate remain gradual, enabling SIRI to continue to pass through music royalties on customers' bills; and (2) the uncertainty has now been removed," wrote Kraft, in the client note. The greater-than-expected 50 basis point step up will only hit Sirius XM's earnings by $16 million, an 'inconsequential' cost according to Kraft.

While the CRB decision won't dampen Kraft's bullish outlook for SiriusXM shares -- the analyst maintains a "buy" rating and $3.30 price target -- it also didn't warrant the 7% Friday rally. "[We] would not be surprised to see the stock give back some of Friday's gain on Monday," wrote Kraft after assessing Sirius XM's $0.20 Friday rise in relation to the rate decision's impact on earnings.

Kraft continues to see Sirius XM as a story of top and bottom line revenue growth, warranting increasing price multiples that have helped to push the company's shares up over 50% in 2012.

The CRB decision does make Sirius XM's costs quantifiable amid an otherwise improving revenue and profit picture for the satellite radio giant. In contrast, streaming music services such as Pandora (NYSE:P) still battle uncertain costs to go with a muddled profitability picture.

Earlier in December, Pandora shares flopped after reporting weaker-than-expected earnings.

While Pandora struggles to generate the subscription and ad revenue to justify its music costs, Sirius XM has benefited from a strong new and used car market in 2012, which has driven 2012 subscriber growth and helps to differentiate the service from competitors.

At the UBS Global Media Conference in early December, Sirius XM chief financial officer David Frear highlighted that the company's improving financial picture hinges on how its non-music offerings are driving subscription growth, primarily in new and used automobiles. Meanwhile, the company's moat around auto subscribers is growing, as car makers continue to post record sales figures.

"You don't have to pay for an '80s channel," said Frear at the UBS conference, of the value proposition Sirius XM offers outside of satellite music streams. The CFO added its non-music content like Howard Stern, nationwide sports play-by-play, and specialized content like CNBC and Bloomberg radio that are driving the company's paid subscriptions.

Sirius XM shares traded $0.02 lower in early Monday trading to $2.89. The company's shares have gained nearly 60% in 2012, on an improving financial picture and a deepening relationship with large minority owner Liberty Media (NASDAQ:LMCA).

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