- Sirius XM’s strong results in Q1 2013 were driven by healthy subscriber additions and control on expenses.
- While royalty costs continued to rise, the company has gained operating leverage by lowering subscriber acquisition costs and general & administrative costs.
- Going forward, we expect subscriber growth to remain healthy although it is likely to come down compared to 2012 which was a stellar year for the company.
- New vehicle conversion rate can suffer due to higher competition in the future.
Sirius XM (SIRI) reported another strong quarter driven by healthy subscriber additions and controlled expenses. The satellite radio company gained 493,000 net subscribers in Q1 2013, and registered 12% growth in revenues and 27% growth in EBITDA (earnings before interest, taxes, depreciation and amortization). 
The key factors driving Sirius XM’s performance include the growth in the U.S. automotive market, increasing penetration in the used car market, Sirius XM’s content advantage, the availability of on-demand service and internet connectivity. Although the net subscriber gains increased compared to the first quarter of last year, the company’s full year subscriber guidance still remains conservative. Let’s take a look at some of the key takeaways of Sirius XM’s first quarter earnings.
Vehicles Sales Outlook Is Positive, But New Vehicle Conversion Rate Was On The Lower Side
Sirius XM’s Performance In New Car Market
Sirius XM continued to see success in the new car market where its penetration rate remained around 67%.  This implies that roughly two-third of the new vehicles sold in the U.S. come fitted with satellite radio equipment. However, the new vehicle conversion rate for the quarter stood at 44%, which was slightly lower than the figure for Q1 2012 (45%).  We believe that it will be difficult for the company to maintain this conversion rate in the long term as competition increases.
However, Sirius XM mentioned that more OEMs (original equipment manufacturers) will join the list of auto companies that install its equipment in their vehicles. In particular, there is an opportunity to sign up more Asian auto makers.  Currently, Sirius XM’s radio equipment is installed in close to 52 million vehicles, which account for about 22% of total registered vehicles in the U.S. The company expects this figure to grow past 100 million in the next five years and 150 million in the next decade. 
Growth In The U.S. Vehicle Sales
The U.S. auto sales for March stood at a little over 1.45 million bringing the total quarterly sales close to 3.7 million.  This implies growth of about 7% over the first quarter of 2012. For the full year, the consensus estimates have increased to 15.4 million.  The growth in the U.S. automotive market is being fueled by an improving economy and higher availability of financing and lease deals. The situation bodes well for Sirius XM, which depends on new car sales for its subscriber growth to a great extent.
Expect More Contribution From Used Car Market
As new vehicles slowly enter the used-car market, Sirius XM will have a greater opportunity to grab subscribers. The company added more than 1 million gross subscribers from the used-car channel in the last quarter, and expects to increase this figure to 1.5 million in 2013.  It also stated that all major automakers have implemented certified pre-owned trial programs and more than 9,000 dealers are offering a trial subscription for Sirius XM’s radio service when customers purchase a pre-owned vehicle.
Service Remains Competitive Due To Content Quality & Internet Integration
Sirius XM’s business model is based on subscription fees and therefore the company is able to afford unique and exclusive content that separates it from other radio service providers. For instance, Sirius XM’s contract with Howard Stern, which was due to expire in 2010 was renewed. The previous five-year contract with Stern was worth $500 million. The company also inked an exclusive deal to provide Stern’s show on its mobile app. Stern is a popular figure and his show attracts over 12 million listeners a week.
Sirius XM mentioned during the recent earnings call that it will shortly launch two entirely new channels - Entertainment Weekly Radio and Comedy Central Radio. These are some of the strongest brands in media and entertainment industry, and the company expects to draw a healthy audience with their launch. In addition to this, Sirius XM engages its customers through live events, private concerts and town hall series that attracts prominent leaders, icons and stars. Also, the company’s on-demand service and Internet add-on have proved successful.
Expense Control Was Impressive
While revenue sharing and royalty costs (as % of revenues) continued to rise, there was a decline in subscriber acquisition costs (as % of revenues) as well as general and administrative costs (as % of revenues). Overall, we expect Sirius XM’s EBITDA margins to continue to grow in the near term.
Royalty Rates are Rising…
Under the terms of the Copyright Royalty Board’s decision, Sirius XM paid royalties of 6.5%, 7%, 7.5% and 8% of gross revenues, subject to certain exclusions, for the years 2009, 2010, 2011 and 2012 respectively. It is likely that the royalty fee will continue to increase in the near future and the company may try to pass on increased costs to subscribers in the form of higher prices. The Copyright Royalty Board has also set the royalty rates for Sirius XM Internet radio. These rates do not apply to satellite radio as it is a different medium. The rates are charged on a per-performance basis, implying that if 100 users listen to one song, it amounts to 100 performances. As the Internet radio royalty rates increase, Sirius XM is likely to pass on these increased costs to its customers, leading to growth in average subscription fee.
.. But Sirius XM Is Gaining Operating Leverage In Other Areas
As we expected, Sirius XM’s subscriber acquisition costs (as % of revenues) declined this quarter. The company already has a working relationship with most auto makers in the U.S. and is a recognized brand nationwide. In addition to this, it is the only satellite radio operator in the country, and therefore, the need for marketing is decreasing. Also, as the company’s operations grow, efficiencies will arise due to economies of scale.
Our price estimate for Sirius XM stands $2.60, implying a discount of about 20-25% to the market price.
- Sirius XM’s Q1 2013 Earnings Transcript
- March U.S. New Car Sales Jump, The Wall Street Journal, Apr 2 2013
Disclosure: No positions