I was chatting with a hedge fund colleague of mine when the talk turned to Sirius XM Satellite Radio (SIRI). He knows I'm overweight in my personal portfolio, and it is one of my larger holdings. (I have a plan on when to lighten, but stay long, but we still have roughly 30% upside before I plan to make any move.) So he says to me, that he's rarely seen a stock with so much noise and chatter. Could I tell him in simple terms why I remain long.
Now noise is a great word when it comes to Sirius Satellite Radio, a company I have followed since its founding as Satellite CD Radio and before it went public in 1994. The past year has seen questions regarding a new CEO, John Malone and Liberty's intentions for the company, the impact of rising auto sales, the company's expansion into used cars, competition with Pandora (P), Spotify, and others, and I can go on and on. On top of that, my hedge fund colleague is at a disadvantage to understanding the appeal of satellite radio as he lives in the New York City metropolitan area, has more than a hundred radio stations at his disposal and doesn't own a car.
So before giving him my answer, I said to him that I'd like for him to consider the following as true: the growth rate for new subscribers will slow and could even flatten and it doesn't matter. Growth has to slow because over time, at some point, current Sirius XM subscribers will buy a new car. Every new vehicle sale will not translate into a percentage growth in the subscriber base. The truth is that there is a critical mass of users for the product no matter what the penetration rate into automobiles is. If Sirius could be found in 100% of vehicles, would that be necessarily bad? After all, it cannot go up from there?
So understanding that discussions as to how fast the subscriber base is growing is simply noise, and which I noticed one analyst this week cited as a reason to downgrade Sirius, a position which I believe shows a real lack of understanding this business model. My answer to my hedge fund colleague was cash flow. So long as the firm maintains a healthy profitability and margins, the cash has to go somewhere - whether via a buyback of stock or a dividend, and both benefit the shareholder over time. Some of it will likely go towards business expansion, whether international or expansion of its online product, but there is enough free cash flow anticipated over the next several years to dramatically reduce the shares outstanding.
The company has been known to low-ball estimates over the previous quarters, and it added 1.66 million new self-pay subscribers in 2012 and forecasts 1.6 million in 2013. With growth 'flat', the $14 per month generated by each new customer this year would generate an additional $268.8 million in revenue. At current levels, this would allow a buyback of an additional 67 million shares .just on revenues generated from the new customers. With roughly 20 million self-pay customers, and 24 million overall, the ability of the firm to buyback 25% or more of the total shares outstanding over the next couple of years is possible. Even with a flat market cap, the reduction in shares will lead to an increase in the share price to $4.50 and above. And that is why I am long Sirius XM