|Shares Out. (in M):||6,559||P/E||0.0x||0.0x|
|Market Cap (in $M):||19,873||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||1,915||EBIT||0||0|
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VIC Write-up: Sirius XM Radio (Long)
Disclaimer: We and our affiliates are long Sirius (SIRI) and may purchase additional shares or sell some or all of our shares, at any time. We have no obligation to inform anybody of any changes in our views of ASCMA. This is not a recommendation to buy or sell shares. Our research should not be taken for certainty. Please conduct your own research and reach your own conclusion
Sirius XM Radio (SIRI) is a provider of satellite radio services in the US and Canada; its product offering consists of music and talk content distributed to a base of 23.9M subscribers, most of whom listen in the car. SIRI has a monopoly in satellite radio (after merging with XM in 2008), and Liberty Media has recently taken majority control of the company.
Sirius XM Radio is a long – the company has a monopoly over a sustainably valuable product category and is set to experience enormous growth in free cash flow per share, driven by strong secular volume growth, operating margin expansion (pricing power + cost leverage), and favorable capital allocation (share buybacks + debt refinancing) spearheaded by John Malone.
Sirius offers a compelling value proposition unlikely to be threatened by internet radio
It’s easy for New Yorkers to forget that the average American spends over 1.5 hours driving each day and that individuals with long commutes (typically higher income) spend even more time in their cars. It comes as no surprise then that SIRI subscribers (who spend 1.7 hours per day driving) find Sirius XM’s music/talk content, user interface, excellent reception (in any location), and lack of commercials to be a compelling value proposition.
These Sirius XM users are highly loyal and have allowed the company to achieve impressive operating metrics and pricing power. ~45% of free trial users become paid subscribers, and monthly churn of paid subscribers has been consistent at only ~2% over time, low relative to other subscription services (Netflix & HBO/Showtime/Starz average 4-5%). Sirius recently passed through a ~5% subscription price increase, which has been put into effect for three fourths of the subscriber base with no effect on customer churn or trial user conversion. Our work suggests the ability for further price hikes.
The debate over whether the integration of Pandora and other internet music services into cars will threaten SIRI’s value proposition is the central controversy surrounding any investment in the company. The debate over the threat of smartphone connectivity is interesting, and our work suggests that Pandora does not threaten SIRI’s value proposition to its actual subscribers, even over the long term. Even if it did, though, we still believe the threat gets inordinate attention from the Street, who may be making mountains out of molehills on both the scale and timing of the threat: Pandora-in-car is totally irrelevant to the 65-70% of SIRI’s 2016 customers whose cars will never have it because they’re too old, and furthermore, internet radio options are already prevalent in many new cars and are having no effect on churn, while the ability of a car to stream Pandora (without a phone) are too far away to be a threat over the investment horizon and will cost money to the consumer when they do arrive.
We also believe that internet radio services do not pose a long-term threat to Sirius’s value proposition:
Strong volume growth (fueled by used car market) and margin expansion will drive cash flow growth
SIRI is likely to see ~10% subscriber growth over the next five years as a result of strong secular tailwinds. A strong continued recovery in U.S. new car sales will allow the company to increase its penetration of the new OEM car base, currently its largest category of customers. The most exciting prospect, however, is SIRI’s rapid penetration of the used car market, which we believe is an opportunity for massive growth. SIRI already was able to add ~1M used car subscribers in 2012, and that number should grow explosively in the coming years:
The result is that the used car customer segment is likely grow into an enormous source of profit for Sirius over the next several years. These customers are particularly profitable and will boost Sirius’s margins because of their low variable costs. Currently, most new cars sold with SIRI equipment require Sirius to pay the OEM manufacturer an equipment installation subsidy; these arrangements are likely to continue for the most part in new cars. Used car customers are higher-margin because they generate the same revenue without this equipment subsidy.
SIRI’s margins will also expand because of the company’s high fixed costs. Roughly 35% of SIRI’s cost structure can be considered genuinely fixed and will fall from 24% of sales to 16% of sales by 2016:
Cash generation will outpace earnings growth and fund enormous share repurchases led by excellent co-investor John Malone
The growth in SIRI earnings actually understates the massive amount of cash the company will generate for several reasons:
The ~$6.7B in cash SIRI will generate through 2016 will have to be deployed somewhere. As Liberty Media has maneuvered to take control of the company, SIRI has authorized a two-year plan to purchase $2B of its own stock, and we believe this plan is only the tip of the iceberg. SIRI management has informed us that the company is likely to re-lever to 3.5x gross leverage to fund buybacks, adding significantly to SIRI’s growth in FCF per share. We also gain conviction in our thesis simply from Malone’s very large bet that now is still a good time to buy the stock.
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