Sirius XM (NASDAQ: SIRI) was recently downgraded by a few firms, Goldman Sachs and Evercore, to equal weight/neutral ratings from buys. Gabelli & Company maintains a sell rating on the firm while other analysts are generally positive in their tone. The valuation creates concern that any missteps could lead to a sell-off in the shares. That said, Sirius XM has executed so far and will benefit from an increasing installed base.
Sirius XM Road to Success Follow U.S. Auto Sales
Sirius XM decided a few years ago that is would target the auto manufacturers so its satellite radio service would come with new vehicles. This would increase its installed base of units and eliminate the need for consumers to purchase separate satellite radio units. Sirius XM service now comes installed on about 70% of U.S. light vehicles.
When a consumer purchases/leases a car, it typically comes with free service for three months or some period of time. After this period, the company aggressively tries to convert the car owner to paying subscriber. The strategy was successful and the company’s share price and earnings have done well. The stock traded at under $0.12 in early 2009 and since then has steadily risen to its current price of around $3.75 per share.
The company has seen the total number of subscribers grow in the high single-digits over the past few years to reach 25.5 million. Self-pay customers have followed a similar growth pattern over this period of time. Importantly, at the end of 2011, Sirius XM had about 40 million cars in the U.S. that already had satellite radio installed as an option. At the end of the third quarter this year, Sirius XM now has an installed base of over 57 million vehicles in the United States. Hence, sales growth at Sirius XM has a close relationship over the past five years with U.S. light vehicle sales.
While the installed base is growing, the company is now approaching a period where its long-time subscribers have owned/leased their vehicles for three to five years and are trading them in for new vehicles. The concern is the company’s growth rate will decelerate as consumers just transfer service to a new vehicle and Sirius XM does not convert the used vehicle buyer to a customer. The degree of this problem and the magnitude of its impact is largely unknown. The positive for Sirius XM could come from buyers of the used vehicles. These could be new customers, although expectations are somewhat low versus new car buyers on their rate of adoption.
Recent Quarters' Results Mixed
In the recent quarter, results were somewhat mixed and led to some shift in the way the stock is viewed.
First, the company announced a $0.50 price increase on their basic package which will take effect in the new year. The company passed on a 12% increase with little resistance from consumers in January 2012 and is expected to do so again. EBITDA in 3Q '13 fell short of expectations but was still up 20% year-over-year; sales increased by 10% year-over-year. Recovering sales in the U.S. auto market contributed to better-than-expected net customer additions in the quarter. Average revenue per user of $12.29 was slightly below expectations but the aforementioned price increase should help this rebound.
Earnings estimates have come down for FY13 over the past 30 days according to Thomson Reuters as a result of concerns on profitability. The Street generally has increased the sales forecast for U.S. light vehicles for 2014 and 2015, which is typically a positive catalyst for Sirius XM sales and its earnings forecast. The FY13 high estimate is down by $0.02 to $0.11 and the mean is down by $0.01 to $0.08. FY14 consensus remained unchanged but FY15 mean was also down by a $0.01 to $0.15. While a penny seems small, based off of these estimates it is 12.5% and 6.5% for FY13 and FY15, respectively. “The first cut is not typically the last” is an old cliché on Wall Street so investors may want to pay close attention if this is the case with Sirius XM.
Key Drivers of the Share Price
The two biggest factors impacting the future stock price and revenue performance of Sirius XM is the growth rate of new light vehicle sales and the conversion rate of used cars. Analysts diverge mostly on the latter and a low conversion, in the 10 to 20% range would likely lead to under performance and one over 30% would likely lead to earnings outperformance over the next few years. The earnings performance would likely translate to increase/decrease in the share price.
Other potential positive catalysts include management having a greater success rate penetrating the Hispanic audience. It has indicated it is increasing marketing efforts in this area and will start offing Spanish language MLB next season and other additional content. Sirius XM could expand into other underserved demographics.
Management released a $2 billion share repurchase authorization earlier this month and will see the average cost of debt decline by 400bp next years. Both are positives but are largely priced into the shares at this point.
While at the current price, it is hard to buy or sell the shares. If an investor could get greater insight into the conversion rate as cars with its service become available on the used market, money could be made long or short depending on where the conversion rate fell. This catalyst will start to play out over the next few quarters and will likely impact the shares one way or another. After this rate becomes more apparent, the more traditional drivers will take over, U.S. vehicles sales, profitability, and success in penetrating new markets.
What are your thoughts on the future of Sirius XM radio?