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Sirius XM Radio (NASDAQ:SIRI)

Piper Jaffray Technology, Media and Telecommunications Conference

March 12, 2013 12:00 pm ET

Executives

David Frear – EVP, CFO

Analysts

James Marsh - Piper Jaffray

James Marsh - Piper Jaffray

Good afternoon. My name is James Marsh, the media and entertainment analyst here at Piper Jaffray. I would like to welcome David Frear, the CFO of Sirius XM today. Very bullish on the Sirius shares here. One of the best business models I think in the media space. The business, it scales well. They have got exclusive access to a content that consumers want. They demonstrate that consumers will pay a premium price for premium content. And I think the business model is one that’s poised to start to generate substantial amounts of free cash flow. So you can understand why Liberty Media has also been very excited about the business as well.

So with that – why don’t I turn it over to David, who can give you a little bit of overview what the company does? And maybe you can just start with – just kind of framing out the broader satellite radio market, the size of it, the trajectory of growth etcetera?

David Frear

Okay. All right. Well, thank you all for taking the time to come over this afternoon. James, thank you for asking me to join you.

Satellite radio launched about 10 years ago and we have done a good job of growing pretty rapidly from zero 10 years ago to 25 million subscribers today, maybe a little bit more if you include the Canadian operations.

The growth has been - initially was off the back of retail distribution and then we quickly moved into new car integration and that’s really sort of propelled us to this 25 million, we have 50 million enabled vehicles that are on the road in the country today. But as most of you probably know there are nearly 250 million vehicles on the road. So we have only just begun to scratch the surface.

So if you think of the growth in phases, with Phase 1 being sort of that launch phase and selling through consumer electronics stores and then Phase 2 being the really tight integration with new car production that’s gotten us up to now about 67%, 68% of the cars roll-off the line have a satellite radio factory installed.

The next phase is as those cars begin to turn over into the used car market and, by the way we continue to build the new car production, so in the next, we have gone from 0 to 50 million cars in the first 10 years of factory installed radios. In the next 10 years, we’ll go from 50 million to a 150 million enabled vehicles. But the real story and I think the next 10 years is going to be about access to the previously owned car buyer. 80% of the households in the countries have a previously owned car in them and 70% of the cars sold in the country every year are previously owned vehicle. So, it’s a market that we have not really tapped in this first 10 years of execution and I think we are going to have a great long-term growth story in the next 10 years.

James Marsh - Piper Jaffray

If you think of new cars sales being in that $15 million plus or minus range, do you have an idea of how many previously owned cars are sold every year? And what percentage of those cars might have satellite radio installed.

David Frear

So it’s about a 70:30 split, if you - just rough numbers, they move around a little bit but figure that there are 50 million cars sold every year, 35 used 15 new, all right.

Now, we are never really going to know how many of the used cars turning over in a year have a satellite radio in them because we just won’t get that sales data. We do get the production data from the automakers. We get all the sales data. So for new car production we know exactly what’s selling? But the used car market, 30% of it is private transaction, I sold a car to you, right and that doesn’t get reported to us, and then there is a lot that are sold through independent dealers, we are trying to capture as much information as we can.

So in gathering that information we have deals with the automakers for their certified pre-owned programs. But that’s probably only about 5% of the used cars that sell in a given year. We signed up with a data exchange program through a subsidiary of ADP, Digital MotorWorks, Inc. DMI where they have sales reporting systems in a lot of auto dealers.

We have over 8,000 dealers that have now signed up so that they send us their sales transactions and we in turn give them a free 90 day trial for their customer to the service. That’s beginning to generate a lot of – what I characterize as hot leads, right. You really want to know who bought the car, you want to know quickly. And then we want to put them through what’s been a very well-tested, well-proven direct marketing methodology that we have been employing in the new car segment, we want to roll it out to used cars.

James Marsh - Piper Jaffray

Okay. When you look at the economics for a subscriber that’s acquired to that new car channel versus the economics of a subscriber through the used car channel, are they much different, do they have different – are the revenue puts different to you, do they have a different churn rates, I mean is there a way to kind of broadly look at those customers and see if they are equivalent to, or one’s better than the other?

David Frear

So, and let me take the last one first on the churn rates, so there is nothing we have seen yet that would suggest that once the person makes that decision to be a subscriber that they behave differently based on what car they own, right? So, self-pay subscribers tend to behave about the same and they can break-up by plan; that monthly subscribers not surprisingly tend to churn higher than annual subscribers do. But we really don’t see any difference in subscriber behavior once they get to self-pay.

From an economics perspective revenue share splits with the OEMs are a little bit different but generally think of them as the same between new cars and used cars. But the big difference is that we subsidize the installation of the equipment once in the life of the car, right? And that’s when it’s originally produced coming out of the factory, there is no subsidy that goes along with the radio after that, so every time you are able to capture they recapture a subscription and a vehicle where we have already put a radio in. You’re just monetizing that investment better [each time] [ph].

James Marsh - Piper Jaffray

Okay, Interesting. Maybe we could talk a little bit about your premium offering? And there is a lot of talk in the market about competition from some of the Internet streaming models that have strong music offering. But obviously there’s much more available on the satellite radio subscription. Maybe you can talk a little bit about what the key differentiators are from a program lined up in your mind and how you package that for consumers that they are willing to pay the premium price point?

David Frear

Okay. So I’m going to take your questions just a little bit differently. We really do believe in a connected world and we believed in a connected world for a long time. So, I know there is a lot of talk now about machine to machine. But, we started with that perspective 10 years ago. And which is why we started streaming our service in the third quarter of ’03, is that we wanted to understand what people thought of subscription radio in a connected world. And since we believe that everything in the world will ultimately be connected, we always knew there would be this two-way opportunity and the opportunity to effectively create, a best in class technology solution for customers in delivering a more robust product set, okay.

So there’s no one that will have the combination of satellite and two-way connectivity over LTE that we will have. And I think that while there is a lot of focus on interactivity and appropriately so that broadband pipes – broadband broadcast pipes are still enormously efficient and have a tremendous amount of value. So this combination of being able to continue to deliver four and a half megabits to the car, with the service availability that nobody else has – the along with whenever they roll out LTE what you can do with connected cars, I think gives us a great advantage over everybody else.

James Marsh - Piper Jaffray

Talk a little bit about the technology that allows you to kind of move into the smartphone, in the past if you wanted to have an experience with Sirius XM outside the car, you would have to have a separate kind of satellite walkman. Now with the smartphone you have access to all these potential users. Can you explain how that could provide some [offence] [ph] as you deal with some of these challenges from some of the streamed Internet players?

David Frear

We developed products years ago with Sonos, Logitech and on our own that were IP connected radios, and so the proliferation of smartphones, is actually a great development for us, it’s great for customer engagement that you – radio is a habit, you like the channel you like to listen to. And so when you can easily extend that by putting an app on a smartphone it just deepens the customer engagement, we feel, we don’t really see it as a primary source of acquisitions, right? There are so much free product free-to-the-consumer product available in the Internet, that it’s not, it’s an extension of engagement for people who’ve decided they want us in the car, that’s really what it is, in which case you extend the engagement with people they are listening to more often, you are more likely to keep them, but it isn’t one of these things and we now know this because there is a 150 million smartphones on the streets in the United States that if smartphone is really going to turbo charge subscription radio, then we would have seen it already, and what it is, is it’s just an extension of product functionality.

James Marsh - Piper Jaffray

The consumer is feeling like they are getting more for their money…

David Frear

Yeah.

James Marsh - Piper Jaffray

You get churn reduced to some degree as well.

David Frear

Exactly, right

James Marsh - Piper Jaffray

Okay. Can we talk a little bit about pricing power, after you, I guess you signed a I guess the Consent Decree to merge Sirius and XM you agreed not to raise prices for some period of time and then recently you have the ability to start to do that again. Can you give us a sense for how consumers have reacted to that, has it impacted churn rates at all, people just paid it, and does that give you confidence you could play with rates in the future?

David Frear

Sometimes you chose not to believe those statistics that that you see because that just don’t make any sense, right? So when we impose the music royalty fee for the first time in, say I think it was the summer of ‘09 that churn went down, right.

I’m pretty sure raising prices doesn’t drive down churn, right. So and when we increased the basic price on the Sirius side of service for the first time in the company’s history a year ago, churn stayed flat. I’m pretty sure that when you raise prices you dampen demand. So while we believe we have a valuable product, we believe that we continue to invest in and enrich that product and just inflation tends to make things cost more over time. That we are pretty cautious about how much of those statistics to believe in terms of then declaring ourselves to have pricing power. I mean we overwhelmingly compete against free to the consumer alternatives.

AM and FM radios free to the consumer, the biggest brand in Internet radio is free to the consumer. The Spotify interactive Internet radio, overwhelmingly the largest component of usage there, is people who are in the freemium tier, so there is so much sort of free to the consumer content especially on the music side out there that we are very cognizant of the fact that consumers have a choice. And so we have to deliver value, we have to deliver service and we’ve got to be careful about what we do with price.

James Marsh - Piper Jaffray

Okay. So it seems like if I look at the top-line, you’ve got auto sales rebounding, right, average car on the road is fairly old, so new car sales are humming along. You got a used car program; you got some pricing power, if you chose to use it. So the top-line seems to be in pretty good shape. Can we drill down to that next layer and talk a little bit about the cost at the business, maybe we could start with content cost and maybe just to buy that into two separate one, just music costs, it seemed to get a lot of play because of Pandora’s discussion music (inaudible). And then two maybe a little bit more about the exclusive deals that you have with various players?

David Frear

Okay. So as you know Sirius and XM beat each other up prior to the merger in bidding for content. And content costs were driven up to levels that probably didn’t make a lot of sense for some of them for what they were delivering in terms of value. But, those were the competitive conditions at the time we did it.

Okay. So now we have been merged for a few years now and we are – we’ve had the opportunity to go in and renegotiate most but not all of those content deals and sort of this post merger sort of world. And as you know, content costs have come down pretty significantly, right. So that the programming cost in the business were about $400 million a year at the time of the merger they are down to about $300 million a year today. That we still have a couple of big ticket contracts that are out there based on hockey long-term deals that come up after the 2015 season so another couple of years before we have a crack at those.

Fox News is another set of pre-merger contracts that has yet to come up for negotiations that’s later this year; it's all great content. We think that the fans of Major League Baseball, Hockey and Fox News really enjoy getting – having their product available on satellite radio. They like to be able to get it in the car. And we are hopeful that we will reach deals with all three of those guys over time that makes sense for both sides.

James Marsh - Piper Jaffray

Okay. Can you help me understand how you evaluate what you should be paying for those contracts when you don’t have kind of the underlying ratings or data to know which consumer is listening to which channel? I mean, how do you guys get a better sense for what’s popular and what’s not on the XM lineup, SIRIUS lineup?

David Frear

Well, we do have for the channels that we saw commercials on. We do gather data that helps with ad sales. We get some audience say that’s helpful. Most of the content that we have is actually created for another purpose, right? And it's being monetized elsewhere. And so you actually have benchmark pricing that you can look at. And so we know in a video world what CNN gets and CNBC gets and Fox gets and the BBC gets, and we know what the major sports league is getting. So that helps a little bit. But, the fact that we represent an extension for those content brands to continue to engage their fans and a way of monetizing that doesn’t really compete with any other platform that it's all upside for them. So it's just a normal business negotiation. I will tell you that it’s probably more art than science, when it comes down to valuation. We are just trying to get the best deal for our subscribers and our shareholders.

James Marsh - Piper Jaffray

Okay. Can we talk a little bit the evolving competitive landscape within the car, recently GM announced they are going to be putting AT&T 4G services in upcoming models, easier to tether your smartphones. So it just seems like a lot’s changed from your early entry into the space when it seemed to me that the biggest challenge was just to get consumers to pay for radio something that they hadn’t done before.

Talk about some of the competitive pressures that you see emerging over the next few years and what should we expect Sirius XM do to respond to some of those challenges?

David Frear

All right. So one of the little known facts is that today we are already the largest provider of traffic navigation screens in cars, all right, so we have data services product that’s within our subscription portfolio and it’s the – couple of different names they go by but NavTraffic is what I think of it. And…

James Marsh - Piper Jaffray

Like an OnStar like…

David Frear

Well, it's actually it’s a traffic product, right, so it just shows you flow data on a nav screen. And the – we will see what consumers value over the long-term in the telematics space, right? So OnStar certainly is the only mature product in telematics in vehicle today that does a full safety and security and concierge services and things like that.

The AT&T deal, I don’t have any inside knowledge of it, right, I only know what I read in the newspapers, looks like a carrier deal, right. The thing I wonder about the carrier based deals with automakers is that their customers aren’t necessarily with that carrier. So exclusive carriage deals I wonder whether or not there isn’t a sub-optimization of that happens in cars just because I happen to be an AT&T customer, so if I buy a GM car that’s great. I’m sure they will have a package plan for me. If you happen to be a Verizon customer maybe it's not so great for you, right, or a Sprint customer that so I wonder about the OEMs aligning with carriers and if that really makes sense especially in a world of – an LTE world where everybody will be deploying the same technology in the United States, right. So we will see how it goes.

The car is very competitive. The automakers realize that consumer electronics, it brings a lot of opportunity to what services they can deliver to customers in the dashboard. And we see that actually as a great opportunity for us that we are the only company I know of who has successfully integrated a consumer electronics product in the dashboard of every single automaker in the country. And so to do that we’ve spent 10 years embedding people in the automakers engineering teams. And we have a very good working relationship with them. Our recent deal that we’ve done with Nissan to provide telematics services is a good indication of where quite honestly we think there is a big opportunity for us there.

James Marsh - Piper Jaffray

It’s real kind of clash of cultures between some of these kind of fast moving kind of creative destruction Internet companies and that slow moving OEM process.

David Frear

It’s really true and it’s why you’ve seen the OEMs establish groups that are kind of maybe more aligned with a fast moving sort of app universe they get, the complexities associated with the slow pace of change in technology and automobiles but the fast pace of change that customers require. We certainly have a lot of experience with helping to manage the customer end of that, we think there are ways we can always help them on the technology end as well.

James Marsh - Piper Jaffray

Okay. I’ve got one last question here before we open it up to the audience. Could you talk a little bit about the CapEx profile going forward? You talked about the efficiency of that satellite network. Obviously it’s built out today but at times you have to replace those birds, kind of where do we stand there and what should we expect going forward?

David Frear

We’ve got the last of this generation replacement, the Sirius 6 satellite that’s due to go up late summer and then we will begin construction on – the first of the XM platform replacement satellite probably in late ‘16 or early ’17. We can think of it as a $1.5 billion roughly replacement spend that you’d stretch out over about 10 years.

James Marsh - Piper Jaffray

Okay. When do you reclaim – you’ve got two networks up there, you got the XM network and the Sirius network, what kind of timetable could you reclaim that network for other purposes, or is it just a – we’ve got too many…

David Frear

I mean, no. It’s an issue that we have been talking about for years and planning for and I think but it’s - for this audience it’s probably a long way out, right? When I sit and I talk to my satellite team, it’s not such a long way out because they do that kind of planning. But it’s in the sort of in a little more than 10 years time we’ll probably be making an active decision about whether or not we want to continue to uplink the 80s channel twice, to do two different satellite platforms. And we will look at the legacy universe. We are moving things off of one platform on to the other platform; we’re overwhelmingly likely over time to build an interoperable chipsets into vehicle. So there is a whole - maybe at stage four or five of growth, there is a whole different monetization opportunity associated with that. But it’s not in the next 10 years.

James Marsh - Piper Jaffray

Follow-up with that in about 8 years.

David Frear

Okay.

James Marsh - Piper Jaffray

With that I will turn it over to the audience. If anybody had got any questions or – we’ve got one here in the front?

Question-and-Answer Session

Unidentified Analyst

I was just wondering if you can give us any kind of read on how (inaudible)?

David Frear

Well, we actually have the largest subscription streaming business in the United States, so at least more subscribers than Pandora has, more subscriber than I understand Spotify has. So, my Sirius XM is just an extension of that streaming product offering. It’s in sort of a beta launch now that feedback is pretty good. I know that I have a good experience with it. And we think we’ll roll out to a commercial launch sometime in the next few months.

James Marsh - Piper Jaffray

Anybody else? Maybe I will follow-up on the content side, as we look forward, are there any areas where you guys think you need to kind of bolster your content offering? Are you are providing enough content for females or for Spanish speaking customers?

David Frear

I think that from a content perspective, we can definitely have a stronger Hispanic content offering and we are focused on improving that. There are areas where we can improve women’s programming to some respects but in a lot of ways that both men and women like rock music, both men and women like Howard Stern. And so the divides in programming aren’t quite that stark.

But looking at speaking to more people more broadly is something that we focus on constantly.

James Marsh - Piper Jaffray

We don’t have any further questions from the audience; we have got one over here from Gene?

Unidentified Analyst

You kind of touched on it a little bit but do you think 10 years down the road what does entertainment look like in the car. I mean what is (inaudible) streaming (inaudible) need for satellite down the road. How does that play out?

David Frear

I tend to think that you can’t have too much capacity, right? And I really don’t see it as all streaming, I think that you continue to burden a wireless network that was fundamentally built for different purposes, they organize it for different purposes, when traffic get stopped on the GW Bridge, they are not going to split that cell again while you are sitting there. So you are going to busy out and end up with latency and all the rest.

So, offloading networks with things that can be naturally offloaded is just a smart thing to do. I don’t see broadcast platforms disappearing and in fact I think that the value in having a broadcast platform married with two-way interactivity is a great opportunity and it’s very cost efficient for consumers because you can bet that data plans - certainly they’re already mobile, but also at home are going to be variable based.

James Marsh - Piper Jaffray

We have got time for one…

Unidentified Analyst

Yeah, so I know it’s early days, but some cars have started shipping – there’s decent number out there that are pre-ready for Internet radio, Pandora etcetera, are your take rates in those cars higher, lower or same?

David Frear

Well…

Unidentified Analyst

One word answer.

David Frear

They are higher.

Unidentified Analyst

They’re higher.

David Frear

They are higher so you tend to – it’s another one of those things where I tend not to believe the data, right. So what I think that is, is I think it’s a set of very technology forward people who want that kind of car, want that enabled vehicle and they are already consuming across multiple channels. We have surveyed our customers a significant component of our customers, stream and stream regularly just like they listened to AM and FM radio; we don’t expect to get them exclusively, all right, but we do expect to deliver value so they believe we are worth paying for.

Unidentified Analyst

Thanks. And who is your main competitor in traffic?

David Frear

Well, I think that [Kochel] [ph] probably has the sort of biggest alternative business in traffic right now.

Unidentified Analyst

Thanks.

James Marsh - Piper Jaffray

With that we are going to wrap it. David thanks very much for your time. We enjoyed it.

David Frear

Thanks James.

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