Weighing Sirius XM’s Risks Againsts Opportunities

Our price estimate for Sirius XM (NASDAQ:SIRI) stands at $3.45, implying a discount of more than 5% to the market price. While there are a lot of things going well for the company, the risks cannot be ignored, which may be one of the reasons why the stock may have pulled back recently after a strong run. Sirius XM has registered strong growth in its cash flows due to growing revenues and increasing margins. The company’s cost control has been impressive, but rising competition and the possibility of a substantial jump in royalty rates remain key risks. Let’s weigh these risks against some of the opportunities for Sirius XM and understand why the current market price may be more or less a fair valuation of the company.

See our complete analysis for Sirius XM

New Vehicles Sales Are Aiding Sirius XM’s Growth

U.S. consumers bought about 1.4 million cars and light trucks in June 2013, bringing the half year new vehicle sales to close to 7.8 million, implying growth of roughly 7.7% over the first half of 2012 . ^[1] The sales went up by roughly 8% in the third quarter of 2013, despite a slowdown in September. For the month of June, the figure jumped 9.2% amounting to 1.4 million units. ^[2] This growth was the highest the industry has seen in the last five years and stood notably above the figure for the first half of the year. August was even better with vehicle sales surging by 17%. ^[3] However, September saw a slowdown as sales fell by 4.2% according to data available from the Wall Street Journal. For the full year, Sirius XM is pegging total U.S. vehicle sales to reach between 15.5 million and 15.6 million, and has raised its subscriber guidance to 1.6 million net additions. ^[1]

Sirius XM’s new car penetration rate stands at around 67%, while the new vehicle conversion rate has remained in the range of 44%-46% for the past few years. ^[4] The company expects more OEMs (original equipment manufacturers) to join the list of auto companies that install its equipment in their vehicles. In particular, there is an opportunity to sign up more Asian auto makers. Currently, Sirius XM’s radio equipment is installed in close to 50-60 million vehicles, which accounts for about 20-25% of total registered vehicles in the U.S. ^[5] The company expects this figure to grow past 100 million in the next five years and 150 million in the next decade. ^[5]

New Car Penetration Rate Can Still Go Up

Sirius XM’s new car penetration rate has increased substantially over the past few years, but has stabilized in the past few quarters. This metric essentially refers to the number of new vehicles sold in the U.S. that come fitted with the company’s radio equipment. Needless to say, the figure depends on the extent of Sirius XM’s relationship with automotive companies and partnerships with dealer networks throughout the country. Every year Sirius XM pays a large sum to its OEM (original equipment manufacturers) partners to keep its radio equipment flowing into the new car market. The company has entered into long-term contracts with car makers such as General Motors, Ford, Toyota, Kia, Bentley, BMW, Volkswagen, Nissan, Hyundai, and Mitsubishi. Several trucks, boats and recreational vehicles also include Sirius XM radios as standard installation. Currently, nearly two-third of new vehicles sold in the U.S. have Sirius XM’s radio installed. The table below shows how this proportion has trended over the past 5 years. While the figure seems to be stabilizing around 67%-68%, there is still room for growth given that Sirius XM has a monopoly in the satellite radio market. It is likely that future car systems will come equipped with multiple services to give owners the flexibility of choosing and changing the entertainment service. This will help Sirius XM expand its installation base.  

EBITDA Margin Could Become Industry Leading

Sirius XM’s EBITDA margin (earnings before interest, taxes, depreciation and amortization) has grown substantially over the last few years driven by revenue growth and controlled expenses. Revenues have increased primarily due to subscriber growth and higher average revenue per subscriber. Besides capitalizing on the U.S. automotive market’s growth, the company has successfully tapped into the used vehicle market with an increasing number of pre-owned vehicle dealer partnerships. The average revenue per subscriber has grown due to price increases, and more subscribers are opting for Internet add-ons. As far as expenses are concerned, it appears that the economies of scale are kicking in. Several key cost components including subscriber acquisitions costs, general & administrative costs, marketing costs and billing costs have come down as a proportion of revenues.

Sirius XM’s adjusted EBITDA margin jumped from 1.9% in 2008 to about 35.3% in 2012. We further expect this figure to reach close to 45% by the end of our forecast period. If we look at other media and telecom companies, we conclude that Sirius XM is on track to become one of the highest margin businesses in this industry. Comcast’s EBITDA margin currently stands at just under 42%, and other media & telecom companies such as Time Warner Cable, Disney, Time Warner, Pandora, Dish Network etc., have lower margins.

What Are The Risks To Consider?

Royalty Rates Are Rising

Under the terms of the Copyright Royalty Board’s decision, Sirius XM paid royalties of 6.5%, 7%, 7.5% and 8% of gross revenues, subject to certain exclusions, for 2009, 2010, 2011 and 2012 respectively. It is likely that the royalty fee will continue to increase in the near future and the company may try to pass on increased costs to subscribers in the form of higher prices. The Copyright Royalty Board has also set the royalty rates for Sirius XM Internet radio. These rates do not apply to satellite radio as it is a different medium. The rates are charged on a per-performance basis, implying that if 100 users listen to one song, it amounts to 100 performances. As the Internet radio royalty rates increase, Sirius XM is likely to pass on these increased costs to its customers, leading to growth in average subscription fee.

Competition Is Increasing

Sirius XM is going to face more competition in the future from players such as Pandora, Clear Channel Radio, Spotify, and potentially Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT). The U.S. radio market stands at around $15 billion. The in-vehicle radio market accounts for roughly half of this, which is why several big players are likely to make efforts to get a share of this market. As competition increases, Sirius XM will find it difficult to grow its subscriber base and could resort to more promotional discounts.

Pandora is increasingly pushing into the automotive segment. In June 2013, the company announced that it was present in more than 100 vehicle models with 2.5 million activations. Similarly, Apple is likely to push for integration in cars for its iTunes radio service. The advantage that Apple has is that the integration of iOS in cars will have multiple benefits including navigation, on-demand music, Apple’s radio service, connectivity to other Internet apps and synching music from Apple devices. Therefore, the company has a strong marketing point and could threaten Sirius XM’s dominance.

Promotional discounts were the primary reason behind the slight decline of 0.8% in Sirius XM’s average subscription fee in 2011. The company stated in its SEC filings that an increase in subscription discounts offered through customer acquisition and retention programs could not be offset by a higher number of subscriptions to premium packages, data services and Internet add-ons. We believe that Sirius XM’s revenue growth will be moderated by the possibility of higher promotional offers as competition increases.

Our price estimate for Sirius XM stands at $3.45, implying a discount of more than 5% to the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. U.S. Car Sales Pace Hits Five Year High, The Wall Street Journal, July 2 2013 [↩] [↩]
2. U.S. Car Sales Pace Hits Five Year High, The Wall Street Journal, July 2 2013 [↩]
3. Robust auto sales keep economy on steady growth path, Reuters, Sept 4 2013 [↩]
4. Sirius XM’s SEC Filings [↩]
5. Sirius XM’s Q1 2013 Earnings Transcript [↩] [↩]