Yes, Sirius XM's Business Model Can Last

Nov.29.12 | About: Sirius XM (SIRI)

In reading a recent article by Richard Saintvilus, who has written in the past for Seeking Alpha as Cameron Kaine, I found myself scratching my head a bit. Arguably one of Sirius XM's (NASDAQ:SIRI) largest bears this year, Richard made an abrupt about face recently.

Consider that a few short months ago, Richard was writing this:

Insanity is described as doing the same things over and over again and expecting a different result. Perhaps its merely stupidity.

Whatever the case, there are investors of Sirius XM pathetically incapable of realizing that the carrot they have been chasing over the past three years is really out of reach. It has become more of a figment of their imagination. They have yet to realize that they have all been a part of someone's poor attempt at humor by being convinced that they can acquire wealth simply by investing in the idea of satellite radio.

He has switched from this stance, now stating he was incorrect and that it is time to buy Sirius XM stock.

That's absolutely fair and I give Richard a lot of credit for admitting he was wrong, although I question whether or not he understands Sirius XM yet. Case in point: Richard's article from today that I quote below, which can be found here. It asks whether or not Sirius XM's business model can last. I found no answer to that question within the article, and quite possibly more confusion than anything.

Part of my confusion stems from Richard's use of certain metrics in a bullish fashion vs. his use of them in a bearish fashion before. What was said before:

For 2011, the company reported 7 million cancellations, while growing subscribers by only 1.7 million. So does that sound like an investment based on anything more than hope -- or as I like to call it, chasing the carrot?

This is now stated as:

Sirius is signing subscribers at a record pace. The company is proving that not only is the model working, but as evident by the 2% churn rate, Sirius is able to retain the majority of the customers it gets - helping it amass $195 million in free cash flow during the quarter.

Both statements cover the same issue, but put a different spin on the numbers. This can confuse readers and investors. I feel it is much better to form an opinion based on the data, rather than form the data around your opinion. A wise investor will remove his or her bullish or bearish bias and emotions from the equation, and focus on the facts.

Getting back to the question posed by Richard: Can Sirius XM's business model last? I certainly think it can. I would like to address Richard's apparent concerns, and hopefully paint a picture of why Sirius XM's business model has done well and will continue to do so.

As it stands, Sirius enjoys a large chunk of the auto market and it's growing each year. But it has not translated to growing profits -- at least not to the extent that would please Wall Street.

On this point, I would have to completely disagree. I feel as if the fact that since near bankruptcy in 2009, when the share price touched a low of under 10 cents, today's share price in the $2.70s shows just how pleased Wall Street has been with the performance of the company. Profits have most certainly grown, as is apparent to anyone who takes a quick glance at Sirius XM's quarterly statements.

For instance, as well as Sirius is performing in its ability to grow subscribers, it also costs the company more money for each new subscriber it acquires. The challenge comes when Sirius tries to squeeze as much profit as possible out of each subscriber. This is where it gets a bit more complicated. During the quarter, the company reported a 5% increase in subscriber acquisition costs.

This is where I smack my head. Of course it costs the company more money for each subscriber acquired. Sirius XM has costs associated with acquiring each subscriber, much like it costs McDonald's (NYSE:MCD) money to purchase the food it sells to you, and much like it costs Ford (NYSE:F) money for steel and other materials to make the car you drive to work. Thus, for each new subscriber, there is a cost associated with it. Subscriber acquisition costs go up and down slightly, but have been in a down trend for some time now, again -- made apparent in the company's quarterly reports.

While there was a slight uptick in the last quarter, this is not indicative of an overall trend. The fact that it costs Sirius XM money to add subscribers is not really a problem, and the fact that the trend is that Sirius XM has been paying less and less per subscriber -- and revenue per subscriber has been increasing -- is a very good thing.

Likewise, sales and marketing expenses grew higher by 10% year over year. Still, the company reported net income of $75 million. But this was 30% lower than Q3 of 2011. It would be fair to point out that during the quarter Sirius also retired $107 million worth of debt, much of which could have gone the bottom line. But it's not all about one-time charges.

Sirius's record rate of subscriber growth also meant that it had to pay 21% more in royalties. As a consequence to subscriber growth, costs of customer service and billings also grew.

But it is about one-time charges. Sales and marketing grew around 10%, yes, but revenue grew faster. Net income was 30% lower due to a one-time charge to retire debt, saving the company money on interest in future quarters. These are good things, and not problems as they are being painted here.

Still, this was not enough to offset total operating expenses, which grew by 9% year over year.

Again, yes, expenses grew year over year, but this is part of doing business and this is not a problem unless expenses grow faster than earnings. Revenue grew, as Richard stated, by 14%, and earnings were greater than expenses previously. It is a wonderful thing that earnings, a greater number, increased by 14% while expenses, a smaller number, increased by only 9%.

Still, investing is about moving forward and investors want to know if Sirius's current business model is sustainable. If the company's expenses rise with every new subscriber that comes, I think it is fair to ask can Sirius do more with less. In other words, Sirius should find a way to get more money from current subscribers and focus less on acquiring new ones.

Let's cut to the chase here. To suggest that Sirius XM is performing well and to suggest that Sirius XM is, as Richard stated:

Overall, the company is performing as well as it can. For that matter, very few companies have executed as well as Sirius over the past three years.

and then turn around and say that Sirius XM needs to change how it operates, focus less on acquiring new subscribers, and focus more on squeezing the current subscribers for more cash is just plain bizarre.

Furthermore, the suggestion of how to do this:

Sirius should consider leveraging its content partnership with Google (NASDAQ:GOOG) and figure out a way to monetize current subscribers by redistributing content via YouTube.

shows a lack of understanding of Sirius XM's business model. Sirius XM pays for its content from musical artists, the NFL, Howard Stern, etc., and does not hold the rights to sell that content or distribute it through other channels. Sirius XM's model is, for the most part, drive-time listening from the dashboard of the automobile, and Sirius XM has proven this works quite well. To abandon the pursuit of additional subscribers for the working model in order to pursue other endeavors far outside the scope of Sirius XM's business would be disastrous.

The answer to Richard's question? Yes, Sirius XM's business model can last, has room to grow, and is proving this quarter after quarter. The only way I see it not lasting is if Sirius XM takes Richard's advice and takes its focus away from acquiring new customers and growing its subscriber base.

Disclosure: I am long SIRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.