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While Sirius XM (SIRI) has not gone so far as to name GM as the manufacturer that will see a shift in its deal this winter, it is widely known that the manufacturer in question is indeed GM. The essential thing that investors need to understand as it relates to the new deal is that it is a positive deal over time that will carry short-term "negatives" in the subscriber metric.

The current GM deal is a legacy deal that provides Sirius XM with PAID PROMOTIONAL SUBSCRIBERS. This is important to note because these are subscribers that are currently counted in the metrics reported by the company, but beginning in Q4 of this year will not be counted. The reason is that they are shifting from PAID PROMOTIONAL to UNPAID PROMOTIONAL. The difference is that an unpaid promotional subscription is not counted in the subscriber number.

If we consider that GM will sell 650,000 cars in Q4 of this year, and that it installs satellite radios in 70% of those vehicles, the subscriber contribution from GM would be 455,000 paid promotional subscribers (650,000 * .7 = 455,000). Sirius XM typically has gross subscriber additions of about 2,600,000 per quarter and deactivations of about 2,050,000. As you can imagine, pulling out some 455,000 subscribers from the gross additions line in a quarter would make the net number much smaller than it would have otherwise been. We are looking at net additions of 550,000 using the old deal, but just 95,000 using the new deal. That is the first and perhaps most important thing for investors to understand.

As I stated early on, the new deal is better for Sirius XM in the longer term, but there will be some "pain" when the switch happens. Essentially, the subscriber number will suffer. This is one reason that the company is making a concerted effort to get the street to focus on self paying subscriber additions rather than net additions.

The old GM deal

In the old GM deal part of the cost of the promotional subscription was paid for by GM. The company receiving revenue for a subscription is the mechanism that allowed these promotional subscriptions to be counted as subscribers.

Essentially, GM paid a discounted subscription rate that equated to about $20 for 3 months. This $20 went into deferred revenue, and then shifted to revenue. GM also got what is called a revenue share on the radio going forward that equated to about $5 per month for the life of the radio as long as it was active. GM receives this revenue even on a second or third owner.

What is being given up by Sirius XM is the revenue that the satellite radio provider would receive from GM. What Sirius XM is getting is a better revenue share deal. In other words, Sirius XM will be paying less on the back end to GM.

What This Means

As discussed, in the short term it means a hit to the subscriber line. In the longer term it means that the revenue share and royalty line will see a decrease, and ARPU (Average Revenue Per User) will likely increase. Here is why.

Sirius XM's current ARPU is $12.14 per month. This means that on average the company is able to garner $12.14 from each member of the subscriber base. As discussed above, GM currently pays about $20, or $6.66 per month for a promotional subscription. Any time a subscriber is paying less than $12.14 per month, the average goes down. While counting some 455,000 subscribers helps the subscriber metric, it is a drag on ARPU. By changing from paid promotional to unpaid promotional, these 455,000 vehicles will not be counted in the subscriber metric used to calculate ARPU.

The impact is not huge, but it is measurable. In fact, beginning next quarter I look for the company to focus on ARPU growth as a result of the additions we will see related to an increase in the music royalty fee as well as the pending change in the GM deal.

Let's look at last Q4 to get a handle on this. Bear in mind that to simplify this I will not use the purchase price accounting adjustments that the company uses (the result of these adjustments lowers ARPU).

  • During Q4 of 2012 the company reported Revenue of $892,415,000.
  • GM Sales were at 628,000
  • The daily weighted average of subscribers was 23,612,000
  • GM satellite radio installations at 70% would have been 440,000
  • Revenue from GM would have been $8,800,000.

The ARPU (without adjustments) was $12.60. Now let's look at the last quarter as if the GM deal were already changed.

  • Revenue would be about $883,615,000
  • GM sales would be 628,000
  • The daily weighted average of subscriber would be about 23,172,000 (oversimplified)
  • Revenue from GM would be $0

The ARPU would have been $12.71. This represents an $0.11 increase in the ARPU metric even with less revenue.

You can see why there will likely be a shift by Sirius XM to begin to focus on the ARPU line. In essence, the company will be able to demonstrate growth in a category while the real function of the end result in self paying subscribers changes little. The 440,000 subs would still convert to self paying at a similar rate, but the drain that a paid promotional subscription has on ARPU will no longer exist.

The beauty of all of this for Sirius XM is that because the company increased the music royalty fee by 40 cents beginning on February 1st, we will already see ARPU climbing slightly before the 4th quarter switch in the GM deal happens.

Essentially, the company lost a couple of cents in ARPU from last Q3 to last Q4, but the metric will start to show increases (so long as retention discounting remains about the same) in Q1 and beyond. By the time Q4 comes into play there will be a new benefit to the line that will show increases.

What Investors Need To Consider

  • The current 2013 net subscriber addition guidance is 1.4 million. The company delivered 2 million net additions in 2012. The common thinking is that Sirius XM is low-balling the subscriber number by offering up 1.4 million. However, If we were to offer up even 10% growth in the first three quarters of this year, the company would go into Q4 of 2013 with 1.6 million subscribers. We can now see that Q4 is challenged by the switch in the GM deal by what will likely be 450,000 gross subscribers additions. This makes the net additions of Q4 challenging to even deliver 200,000 (and that is aggressive). Simply stated, the odds of matching the 2 million net additions of 2012 is unlikely even with higher auto sales.
  • The longer term impact will be positive to ARPU because lower than average rates will be removed from the equation.
  • The revenue share and royalty line will see savings because the revenue share will be decreased.
  • The focus will shift to Self Pay additions because that metric will see benefit from the GM shift.
  • ARPU will see focus because it should be able to increase for quite a few quarters in relation to the music royalty fee as well as the GM shift.
  • Deactivations will decrease because these GM cars are no longer counted as subscribers unless the consumer elects to become self paying.
  • The impact on churn is initially minimal because promotional subscribers are not used in determining churn. Longer term the impact is positive because the self pay line will increase as consumers convert.

Investors should notice that the company is asking you to shift your focus. That is fine as long as you know the reasons why that shift in focus is being made. Now you know, and as an informed investor you have an advantage. The other secret is that the vast majority of investors do not know these dynamics, and it could present a great opportunity to take advantage of the situation.

Source: How The GM Deal Will Impact Sirius XM