Deep Dive – $SIRI

by Enis December 27, 2013 11:42 am • Commentary

Sirius XM Holdings was a darling of the late 1990’s internet bubble, when the stock rallied from single digits to almost $70 over the course of the cycle.  Satellite radio was a novel idea, with the attendant enthusiasm.  Even though the company did not turn its first profit until 2010, the stock’s best days by far were more than a decade ago.

However, SIRI today has gotten over the youthful days of building out its network, and has real earnings and a widespread distribution model.  It’s a $22 billion market cap company that has earned $500m-$750m in each of the past 3 years.  Earnings are expected to breach $1 billion in 2016.  Sales have risen about 10% per year since 2010, and are expected to continued at that pace for the next few years.

In its more recent quarterly report, management described its operations as follows:

We broadcast our music, sports, entertainment, comedy, talk, news, traffic and weather channels, as well as infotainment services in the United States on a subscription fee basis through our two proprietary satellite radio systems. Subscribers can also receive our music and other channels, plus new features such as SiriusXM On Demand and MySXM, over the Internet, including through applications for mobile devices.
We have agreements with every major automaker (“OEMs”) to offer satellite radios as factory or dealer-installed equipment in their vehicles from which we acquire a majority of our subscribers. We also acquire subscribers through marketing campaigns to owners of factory-installed satellite radios that are not currently subscribing to our services. Additionally, we distribute our satellite radios through retail locations nationwide and through our website. Satellite radio services are also offered to customers of certain daily rental car companies.
As of September 30, 2013, we had 25,582,066 subscribers of which 20,670,333 were self-pay subscribers and 4,911,733 were paid promotional subscribers.
Its agreement with the automakers is clearly its biggest competitive advantage.  Potential competition on that front is likely the biggest risk.  As for the stock, it skirted potential bankruptcy in 2009 with the help of an emergency loan from Liberty Media (who still owns 53% of the company), and has been on a long-term uptrend ever since:    
[caption id="attachment_34212" align="alignnone" width="600"]SIRI weekly, Courtesy of Bloomberg SIRI weekly, Courtesy of Bloomberg[/caption]

Dan outlined his own views on the stock in his trade post on Tuesday:

In all seriousness, what got me once again thinking about the stock is the enthusiasm about Pandora in the public market, sporting an almost $6 billion market cap with far fewer paid users (about 3 mil paid, 70 mil total) than SIRI, trading at almost 9x sales, and Spotify, which is private, but recently raised a bunch of cash placing a value on their 6 million paid users north of $4 billion.  SIRI by no means is a cheap stock with minimal earnings, but the company has grown sales at about 10% a year for the last few years and analyst expect them to continue to do so.

My sense is that SIRI could start to be viewed in a different light if some of these less established streaming upstarts continue to see their valuations expand in the new year.  Also, SIRI has long been considered a strategic asset (with 25 million paying subscribers) as one of the few outlets into in-car entertainment, I would have to assume that the company’s $22 billion market cap does not preclude it from being a potential take-over candidate from other large media properties or even a technology company such as as AAPL or AMZN could have multiple uses for such a service.

I agree with Dan that on a relative basis, SIRI is a much more desirable asset than Pandora or Spotify.  It took 15 years for Sirius XM to build the relationships with car manufacturers, content providers, and subscribers that has led to today’s vast subscriber network.

However, I see 2 main reasons for concern.

1)  Management does not instill confidence in future growth prospects with its recent buyback strategy.

The company generated $745 million in free cash flow from operations in the first nine months of 2013, but bought back $1.6 billion in stock.  The extra cash was of course provided by taking on more long-term debt, but that’s hardly a reason for comfort.  The debt issued this year have interest rates between 4 and 6%, but when free cash flow yield is also only in the 4-6% range, the strategy looks less than reassuring.

2)  With little valuation history, investors have a hard time assessing what should be the appropriate earnings multiple today.

The stock is trading around 40x earnings.  Expected earnings growth is expected to be in the 20-25% range over the next couple years, so that’s not necessarily expensive, but since the company has only been profitable since 2010, assessing the current valuation profile is difficult.

The Goldman research analyst has had a nice call on the stock, and actually downgraded it near the October highs, with the following note:

Looking for a better entry point from here. We still see a number of drivers supporting the SIRI story, including strong volume growth (SAAR improvements, used car opportunity), margin expansion (reset with a large OEM partner in 4Q13), and outsized FCF/share growth (supported by a sizable share buyback). That said, we look for a better entry point from here, as shares have only 9% upside to our price target from current levels.

That about sums up my own view as well.  The stock is probably cheap near $3 and fairly valued near $4, with no strong view in between. Which means this stays in the trading column for now. Close to $3, we may look to this stock for the longer term and think of it for the investment portfolio. Until then we’ll look to trade around technicals like with the recent buy on the 200 day moving average.