With Sirius XM Radio (SIRI) set to release its first quarter earnings next week, where should investors focus? Investors should not get distracted by worries about whether or not "interim" CEO James Meyer is named the permanent CEO or whether a new CEO from outside the company is named. Nor should there be too much focus placed on whether or not the previously announced $2 billion share buyback program has begun -- or even finished. Instead, the focus should be on the basic fundamentals. Which fundamentals are these?
As always, the key numbers will be the subscriber metrics. These are the numbers Sirius XM reports each quarter and that give investors and analysts insight into how well the company performed in the most recent quarter and how well revenue, earnings and free cash flow could be expected to grow in the future. They include the self-pay monthly churn, new vehicle conversion rate, average revenue per user (or ARPU) as well as two other pieces of information that may or may not be addressed in the 10-Q -- an update on the used car program and the new vehicle penetration rate. Taken together, these pieces provide the information needed to understand revenue. On the cost side, the other major piece of data released each quarter is the subscriber acquisition cost per new OEM-equipped vehicle (or SAC).
Subscriber growth starts with free trials offered to buyers of new and used vehicles. However, not all of the free trials are initially counted as subscribers. If the trial is a paid promotional subscriber, it is counted as part of the Sirius XM reported number of total subscribers. At the end of the paid promotional trial period, if the trial converts to a self-pay subscriber, the subscriber is moved to the self-pay subscriber pool. If that paid promotional subscriber fails to convert to self-pay, it becomes a deactivated subscriber.
The other new car trial subscribers -- those not on a paid promotional subscription -- get counted as subscribers only if they convert to self-pay subscribers. Similarly, used car buyers that receive a free trial do not get counted as subscribers unless the conversion to self-pay subscriber takes place. Why are these distinctions important?
When 2013 guidance was issued in early January, the company forecast total subscriber growth of 1.4 million subscribers, but self-pay subscriber growth of 1.6 million. These figures compare to 2012 total subscriber growth of just over 2 million and self-pay subscriber growth of nearly 1.7 million. The significant drop in total subscriber growth has been partially attributed to one large OEM (believed to be GM) shifting from paid promotional trials to unpaid trials in the fourth quarter. So, while self-pay subscriber growth might be expected to grow evenly throughout the year, the quarterly total subscriber growth will be heaviest in the first three quarters. What at first glance may appear to be a large Q1 number may be the one expected by the company.
ARPU is expected to show growth in the first quarter. On the previous conference call, CFO David Frear stated:
The ARPU will continue to pick up. Remember, it takes a long time for things to roll through, and so believe it or not, we're only just shaking off, now, the effects of the reduction in the music royalty fee from $1.98 to $1.42 that went through in December of 2010. That negatively impacted our ARPU numbers all year. In the first quarter, we'll pick that up, and so ARPU should grow.
And it's not just the impact of the music royalty fee decline. That fee was increased on February 1st, so we should also begin to see some small benefit from that. On that same call, Meyer stated:
I can tell you, and if you're a subscriber whose account renewed in February, for instance, you have been notified of a change in the MRF, and a passing along of that.
Also, the basic monthly subscription rate increase from $12.95 to $14.49 is still rolling through the subscriber base. Other factors, such as the mix in paid promotional trials and self-pay subscribers, and retention discounting also impact ARPU.
To a certain extent, Sirius XM can manage subscriber growth by how aggressively the customer service department engages in retention discounting. Previously, Sirius XM disclosed that it offers discounts to 14% of its self-pay subscribers. Whether it offers discounts to more customers or deeper discounts, can impact the conversion rates, churn and the number of subscribers.
Costs should rise as the business grows, especially the music royalty. The royalty rate will increase again this year, climbing to 9% of certain Sirius XM revenues. Most other costs should also continue to increase. The total subscriber acquisition costs -- the single largest cost for Sirius XM -- should rise as more satellite radio equipped vehicles are sold, although the SAC per vehicle would be expected to hold steady or decline.
Another cost that will likely grow this year is the customer service and billing expense. The monthly amount per subscriber grew, and it was partially attributed to the increased length of time spent on each call. Investors should pay careful attention to this figure, as it grew sharply in the fourth quarter of 2012.
I don't expect to hear very much about the used car efforts until the conference call, and even then, I am not expecting much. All we know is that when the last call took place, Sirius XM management expected the program to generate about 1.5 million gross addition equivalents in 2013. It would be interesting to find out if management is ready to increase that number. I also expect investors will get an update on the number of used car dealers in the program, reported to be over 8,000 on the previous conference call.
When Sirius XM reports earnings next week, news about MySXM or the latest deal with BMW or a new CEO or telematics or even the status of the share buyback may garner some attention on the conference call, and may even be important for the company's longer-term growth. Just don't lose sight of those areas where the company needs to perform well today.
Focus on the same key metrics that have been important drivers to the company's revenue, profitability and free cash flow for the past few years. These are the churn and conversion statistics and the growth in both total subscribers and self-pay subscribers. And make sure that the growth is not coming at the expense of ARPU.
Additional disclosure: In addition to my long positions, I have January 2014 $3.50 covered calls written against many of my long positions in Sirius XM. I also trade blocks of Sirius XM on a regular basis.