We reiterate our long stance on Sirius XM (SIRI) based on the recent strong results posted by the company. SIRI was able to generate an impressive growth in its revenue and free cash flows in the quarter. Moreover, based on the strong net subscriber additions and improved auto-sales, it has revised its net subscriber additions' estimates upward, which is a bullish sign. Auto-sales are expected to increase by over 4% in the FY 2013, which would bring further growth to the company's subscription revenue.
The improvement in free cash flows also signals that the company will return some capital to its shareholders in the shape of share repurchases, which was hinted by its management in the recent conference call. Moreover, the increased stake in the company by Liberty Media Corp. (LMCA) could also drive the stock price up.
Sirius XM, the largest US satellite radio company, is a provider of radio services at home, in the car and on the go through smartphones and internet. It is a $14 billion enterprise with approximately 23.4 million subscribers as of the quarter ended September 2012. The stock is currently trading near $2.7, 10% off its 52-week high of $2.97.
The company reported strong financial results for the quarter with growth seen across key business metrics. Revenue jumped 14% in Q3 2012 compared to the third quarter of the previous year, beating analysts' estimate of $866.1 million. Net income, however, fell during the quarter to $74.5 million, a 29% drop, largely due to a $107.1 million charge in debt payments.
Other highlights of the third quarter include:
- Operating cash flows of $513.5 million, an improvement of 56% over Q3 2011.
- Growth of approximately 160% in free cash flows in the quarter.
- The company extinguished approximately $866 million of its debt in the quarter. As a result, SIRI's leverage has improved. In Q3 2012, its leverage was reduced to 2.8 times its EBITDA, down from 4.3x at the end of Q3 2011. Moreover, the company does not expect any debt maturities in the next two years, which will give it more breathing space, if it pursues strategic options.
Rising ARPU and net subscriber additions
The company derives the major chunk of its revenue from subscription fees, which account for almost 90% of its total revenue base. Revenue from subscriptions increased by an impressive 15% in the quarter, which was largely due to the increase in subscriber base as well as the price hike that the company introduced early on in the year. The company continues to show tremendous growth in its total subscriber base which reached approximately 23.4 million customers by the end of the third quarter. Not only does it represent a growth over the same quarter of the previous year, but also it marks another quarter of sequential growth in subscribers. The company added a total 0.45 million subscribers, 34% higher than what it managed to achieve in Q3 2011.
The growth in subscribers achieved in the quarter was largely due to higher vehicle shipments and light vehicle sales as well as a high new vehicle conversion rate. New vehicle conversion rate is the percentage of owners of new vehicles that convert to self-paying customers after the initial trial period of using the company's services is over. The said conversion rate in the quarter was a very high 44%.
Due to recessionary pressures, an increasing number of customers are switching to smaller cars. Although the switch is eating into the margins of car manufacturers in the region, it has benefited SIRI. The table below shows the recent upward trend in the sales of light weight vehicles.
Hike in subscription rates driving ARPU higher
As mentioned previously, the company continues to benefit from the recent increase in its subscription rates, which is reflecting positively in its key metric: Average Revenue per User (ARPU). ARPU jumped in the quarter to $12.14, an improvement of 4% over Q3 2011. In January, the company increased the base price of its subscription packages to $14.50 from the previous $12.95, and by the end of the third quarter, almost 55% of its subscribers were using the new service plan. We expect the strength in ARPU to continue.
The company's management has revised its previously issued guidance for the full year. It now expects to end the current year with total net additions of 1.8 million subscribers, which it is on track to achieve. This is an upward revision from the previous addition estimates of 1.6 million subscribers. Moreover, a staggering 160% growth in free cash flows also suggests that the company will be able to achieve the target of $700 million for the full year.
As mentioned previously, the company has maintained its new vehicle conversion rate at a very high level of 45% over a number of quarters now, which is a bullish sign. Moreover, despite Hurricane Sandy, the auto industry was able to sell 1.087 million cars in the month of October, which represents a 7% growth over the same month of the previous year. Analysts expect auto sales to be around the 15 million mark in 2013, which is a growth of 4% over the estimates for 2012. If this upward trend in car sales continues, the company is headed for yet another boost in its revenue, as buyers will most likely subscribe for its radio services.
During the company's conference call, its Chief Executive Officer, Mel Karmazin, hinted at the possibility of returning capital to its shareholders in the absence of any acquisition opportunities. Analyzing the company's free cash flows and recent growth, it seems likely that the company will buy back some of its stock next year. According to Barclays' analyst, James Ratcliffe, the company is expected to buy back its stock in 2013. He expects $2.9 billion in repurchase, which represents approximately 21% of the company's market cap.
Liberty's control over SIRI
According to a filing, Liberty Media, the biggest shareholder for SIRI, has increased its stake in the company to 49.8% through the purchase of almost 31 million shares. With the recent increase in stake, the company is now awaiting the green signal from the Federal Communications Commission to exercise control over the company. Liberty Media's CEO, John Malone, recently said that he plans to sell off the stake to Liberty's shareholders under the terms of the Reverse Morris trust, which, effectively, is a positive sign for the shares of SIRI. Its shares have already shown gains on acquisition talks. Even if Liberty does not exercise the so called Reverse Morris trust and decides to hold on to SIRI's shares, it is likely that investors will remain bullish on SIRI based on its subscription growth and the improvement in its key business metrics.
Sell Side review
Currently, 70% of sell side analysts are bullish on the stock and 25% have a hold rating. Citigroup has increased its target price from $2.8 to $3. Bank of America, which has recently initiated coverage of the company, has also recommended buying SIRI, and has a target price of $3.75.
SIRI is trading at 27 times its forward earnings, which is a significant discount (70%) to what Pandora Media Inc. (P) is trading at. Shares are up approximately 50% on YTD basis. Based on the revenue estimate of $3.8 billion for FY 2013, we arrive at a target price of $3.1, an upside of 15% based on the current price of $2.70. SIRI has a long-term earnings growth rate of 28%. Based on 2015 EPS estimates of $0.14 and a forward price to earnings of 27, the implied target price is $3.78, an upside of 40%.
SIRI's business model is heavily dependent on the auto industry which in turn is affected by various factors that include available credit, economic conditions, and overall consumer confidence. A decline in vehicle sales and the resultant decline in satellite radio penetration may adversely impact the company's profitability.