We often see companies issue press releases related to various announcements associated with the business. Sometimes press releases are geared toward consumers and other times they are geared toward investors. Typically press releases point to some positive event that is taking place, and rarely do they actually tell the entire story. That is fine, because press releases are usually designed to outline positive developments. It is an investor's job to take in the information, conduct some thoughtful research, and determine if it is an accretive event as well as over what time period it will be accretive.
I often see the investment community of Sirius XM (SIRI) discuss the new car segment of the market and how many satellite radios are being installed. In a recent article about February auto sales it became clear that not all investors actually think through all sides of an equation. In particular the focus seems to be on whether sales are up and how many satellite radios are being installed. The company calls the installation rate the "penetration rate". It refers to the percentage of new cars that come equipped with satellite radio.
About a month ago it was announced that Sirius XM and Toyota had expanded their deal to incorporate more satellite radio installations within that automakers 2013 offering. It was seen as good news by investors and it is. It is not "huge" news though, and the difference between the old deal and the new deal needs to be looked at more deeply than simply the penetration rate.
Sirius XM has been at the satellite radio business for quite some time now. The company has a good sense of what types of cars deliver the best chances for successfully adding a self paying subscriber as well as how fast or slow expansion should happen. What investors should be doing is what the company does. What we need to do is look at this issue from all angles. The possible benefits as well as the cost.
There is a cost associated with each and every satellite radio installation. The cost happens today in hopes for a benefit over time. The goal is to garner the maximum benefit for the least amount of cost. Satellite radio is not for everyone. This has been demonstrated over time in the fact that about 56% of those that get exposed to the service elect not to carry on with a self paying subscription. Sirius XM is well aware of this and has built it into its business model. The company knows that for every 100 cars made about 70 will have satellite radios. It also knows that out of those 70 installed radios it will garner about 31 self paying subscriptions. Does it make sense to boost installations to 80% if the self pay line only moves up by 1 person? These are the dynamics this company, and thus investors, should consider.
Automobiles are not created equal. Some cost a lot of money and others are pretty cheap. Typically the more money someone makes the more likely they are to buy a more expensive car. Higher end cars are usually bought by people that have more discretionary income. People with discretionary income can afford a luxury like satellite radio. Clearly certain cars, and by extension consumers, are more likely to subscribe than others. This is the main reason that we have seen the installation rate remain between 60% and 70% for quite some time. Simply stated, it does not make financial sense (at this point) to install a satellite radio into every car.
The Important Metrics To Watch
- Penetration Rate
- Conversion Rate
- Subscriber Acquisition Cost (SAC)
If Sirius XM were to announce that it will be installed in 75% of all vehicles tomorrow there would certainly be some investors that would celebrate the announcement because it is good news. Savvy investors would celebrate the announcement because they trust that management knows what it is doing, but would also begin to investigate how this announcement may impact various metrics.
What the company watches closely on this subject is not how successful it is at converting, but whether it is spending too much money for a return that is not as great. This is where investors should keep their focus as well.
Notice that over the past three years the penetration rate has been increasing while the conversion rate has remained fairly flat or even a slight decline. Sirius XM seems to want the low end of the conversion rate to be about 44%, where it currently sits. This is why the company will be selective in exactly what cars satellite radio is installed in as well as how many of those cars get installation. It only makes sense.
If we were to see the take rate increase to something like 48% it would likely signal that the perspective audience of Sirius XM is growing and more people want the product. At that point it would make sense to expand the offering into more cars. The other consideration is the average cost per gross addition. Sirius XM wants to keep that between $50 and $60 and has done a great job at accomplishing that goal.
With the expanded Toyota deal Sirius XM indicated that Toyota would ramp up installations over the next few years. Now investors can understand part of the reason that this more of a process than a simple decision to run wild installing radios. What you will want to monitor is how the take rate.
So should Sirius XM increase the penetration rate? The answer is yes, but in a responsible manner that does not upset the apple cart of other metrics. That is what the company has done for years now, and that is what we will hopefully see continue with Liberty Media (LINTA) in control.
Additional disclosure: I am long Liberty Media