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For well over a year, Sirius XM Radio (SIRI) has been pushing the idea that the idle radios out on the road will provide a significant growth opportunity for the company. To address this market, the company is offering a 90-day free trial to the buyer of any used car with an OEM-installed radio sold by a participating dealer. The number of dealers in the program has grown rapidly, from 103 at the end of the first quarter of 2011 to more than 9000 as of the last conference call.

Management has discussed this opportunity by focusing attention on the number of vehicles on the road that have OEM-installed radios and how this number will be growing over the next decade. On the recent call, CEO James Meyer discussed the opportunity without disclosing too many details about the success:

SIRIUS XM entered the first quarter of 2013 with nearly 52 million satellite equipped vehicles in operation, up from 42 million a year earlier. This means our satellite radios are installed in approximately 22% of all registered vehicles on the road. Since our new car penetration rate is about two thirds the trend of growing vehicles in operation will just keep going for many years to come. By the end of 2017, we should have around 100 million satellite equipped vehicles on the road and in 10 years time we should see about 150 million. Within a few years, we expect more used cars to be sold with satellite radio than new cars. These stats highlight our easily addressable market opportunity and provide the corner stone of our growth. Last year we exceeded our goal of more than 1 million self-pay additions from the used car channel and this year we plan to hit an ambitious target of more than 1.5 million self-pay additions from used cars.

Subsequently, CFO David Frear stated:

Aftermarket original owner and subsequent owner where year-over-year growth was consistent with our expectations that we will add more than 1.5 million new subscribers from the subsequent owner market this year.

These statements appeared different from past statements, including the fourth quarter conference call where Meyer referred to the 1 million and 1.5 million as "gross additions." Is there a difference? And, how should investors think of these figures?

Each quarter Sirius XM presents a table that shows subscriber activity. It starts with "Beginning subscribers" and then adds the "Gross subscriber additions" that took place during the period and subtracts the "Deactivated subscribers" that took place during the period, resulting in the "Ending subscribers" and the "Net additions" for the period. Unfortunately, the figures do not capture all the activity that took place during the quarter.

The Gross additions include:

  1. New OEM "Paid promotional subscribers",
  2. Conversions of new OEM unpaid trials to Self-pay subscribers
  3. Conversions from free trials to Self-pay subscribers acquired through the 9000 dealers in the used car program, and
  4. Other activations or re-activations of self-pay subscriptions.

The Deactivated subscribers include the Paid promotional subscribers that chose not to convert to self-pay subscribers (represented by [1 - the conversion rate] ) and the Self-pay subscribers that cancel (the Self-pay monthly churn rate).

What the company does not officially report is a portion of the unpaid trial activity. This includes both the unpaid trials that certain OEM's provide with the purchase of a new vehicle, as well as those 90-day used car trials provided by the 9000 participating used car dealers. If these unpaid trials do not convert to a Self-pay subscriber, they do not get included as Deactivated subscribers or Gross subscriber additions. These trials only get included in the Gross subscriber additions if they convert to a self-pay subscriber, at which time they are also included in the Self-pay subscriber totals.

When guidance was issued earlier this year, a point was made to have investors and analysts focus on self-pay subscribers. The change in language on the most recent conference call where the "more than 1 million gross additions" for 2012 and the "1.5 million gross additions" for 2013 to "self-pay additions" may be part of this change in focus. Regardless, the terms appear to be used interchangeably by Sirius XM when referring to the used car program.

So, where will these 1.5 million self-pay subscribers for 2013 originate? A portion will be conversions of the free trials offered through the 9000 dealers in used car program. Others will come from buyers of used cars that recognize that they have a Sirius or XM satellite radio in their car and find their own way to Sirius XM and sign up for the service. At the Piper Jaffrey conference earlier this year, Frear made the following observation:

...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.

In addition to the 30% of private used car transactions, we also know that Sirius XM will not be signing up every used car dealer in the country. That indicates that there could be a significant number of used car activations that will be dependent on potential subscribers finding their own way to Sirius XM.

There are several pieces of used car program data that remain unknown to investors:

  1. The number of 90-day trials offered through the participating dealers
  2. What percentage of these used car trials convert to Self-pay subscribers
  3. The level of discounting and ARPU for the used car transactions.

Frear gave a partial explanation about the reluctance to disclose the information as far back as the 2011 third quarter conference call:

Reactivations is actually an incredibly broad category of things. I think when most people talk about it that they tend to think of it as subsequent owners of a radio, primarily a vehicle, and developing confidence in those statistics is going to take a little time. We know for sure whenever a radio turns off and turns back on. What is a little more difficult to tease out of the information is who owns it? Is it an existing subscriber who's reactivating a few days after a trial ends or after -- maybe they get disconnected for non-pay, or is it a subsequent owner of a vehicle? That we frequently find with the timing of information sent to us by some of the automotive partners is that you can often have a radio that's still on for a car that's been sold. The new car buyer -- the used car buyer gets it. And they're actually calling us to "activate" their radio before we've been informed that the car has actually changed hands. So again, I think the short story is that over time, that as we can get confidence in the measurement of the numbers, we'll probably talk more to you about subsequent owners. But reactivations at this point is just sort of a pretty steady consistent contributor to all the underlying metrics you're looking at.

And, on the subject of the conversion percentage, Meyer made the following comment:

Regarding used car conversion, as Mel mentioned, we're pleased with the conversion so far that we've seen on certified preowned vehicles. It's not as high as new cars. It's, in fact, it tracks in the mid- to high 30s right now. I think it's too early to say what the long-term trend of conversion is going to be in used cars, because like many -- if you remember, in a new car conversion, it takes a while to figure the cadence, the proper cadence, and the proper offer strategy and a proper follow-up to optimize that number. And used cars, that we're still relatively new at it. I don't believe at all it'll ever be as good as new cars, but I do believe that it will be very, very strong and a good contributor for our growth for many years.

Apparently management still does not have "confidence in the numbers."

Number of Satellite Radio Equipped Vehicles

The growth in the number of satellite radio equipped vehicles on the road is, in many ways, a mixed blessing. While the number on the road grew by 10 million from 42 million to 52 million, the number of paid subscribers during that period (calendar 2012) grew by 2,007,512. Since those 10 million additions generated 2 million paying subscribers (promotional and self-pay), the addition of the other 8 million vehicles to that pool represents 8 million subscribers that chose not to pay for the service.

Total Trials

During the conference calls, one of the numbers that investors should consider is the total number of trials. This figure includes both the paid promotional subscribers and the unpaid, or free, trials. It is an important number as it represents the source of most of the company's future self-pay subscribers. On the most recent call, Frear stated:

Total subscribers now stand at 24.4 million. Self-pay subscribers are up 9.2% from first quarter '12 and our trial final amount stands at 6.2 million.

We know that the number of "Paid promotional subscribers" was 4,478,566 at the end of the first quarter of 2013 and can derive that the unpaid trials stood at 1.7 million. Also known is that the current total number of trials is up 0.1 million from the 6.1 million at the end of 2012 and up 0.5 million from the 5.7 million total number of trials at the end of the first quarter of 2012.

Since the number of paid promotional trials at the end of 2012 was 4,330,062, the number of unpaid trials was 1.8 million at the end of 2012. This indicates that the number of unpaid trials actually declined by 0.1 million in the most recent quarter.

At the end of the first quarter of 2012, the paid promotional trials stood at 4,089,330. Since the growth in total trials was 0.5 million over the past year, the unpaid trials only grew by 0.1 million.

The sequential decline of 0.1 million in the number of unpaid trials occurred at the same time that the number of dealers participating in the program increased by 1,000. The small increase of 0.1 million in the number of unpaid trials over the past year occurred at the same time that the number of dealers participating in the program doubled from 4,640 to more than 9000. And, since the unpaid trials tied to new car sales should have been growing, the overall lack of growth is surprising.

Summary

There is no doubt that the number of used car subscribers, especially self-pay subscribers, has become increasingly important to Sirius XM. The disclosure that last year more than 1 million subscribers originated from this opportunity and that it is expected to grow to about 1.5 million in 2013 would support this position. And, as management has pointed out, the cost of the radio has already been expensed, so in that respect, it is a more profitable subscriber. On the other hand, it is also possible that the increase in customer service and billing expense per month per subscriber is attributable to the used car effort being a more difficult sale.

Meyer alluded to this difficulty when he noted the lower conversion rate for certified pre-owned vehicles and his comment that he did not believe "it'll ever be as good as new cars." Considering that certified pre-owned vehicles tend to be newer and more expensive models, expanding the program to less expensive and older used cars would suggest that the conversion percentage would be lower than the "mid- to high 30's." If that's the case, how much benefit will the used car program provide?

It is difficult to assess the eventual impact, mostly because many of the key metrics have not been disclosed. There has been no data provided on the number of trials that originated from the 9000 dealers in the program, the percentage of those trials that convert, whether they require more incentives to convert, the ARPU from these subscribers, and whether or not the churn rate differs from that of new car subscribers.

As Meyer stated:

By the end of 2017, we should have around 100 million satellite equipped vehicles on the road and in 10 years time we should see about 150 million. Within a few years, we expect more used cars to be sold with satellite radio than new cars. These stats highlight our easily addressable market opportunity and provide the corner stone of our growth.

I believe that the used car opportunity will provide the cornerstone of growth at Sirius XM, especially as the growth in new car sales slows down. Unfortunately, I see little evidence to suggest that it is an easily addressable market opportunity. And before getting too carried away by the 1 million self-pay additions in 2012 or the 1.5 million in 2013 from the used car opportunity, remember that these were not called net additions and there will be a growing pool subject to cancellations from the self-pay monthly churn.

52 million satellite equipped vehicles are on the road today. There will be 100 million by 2017 and 150 million in 10 years. The numbers have a nice ring. However, they also represent a lot of idle radios in the cars of folks that won't pay for radio.

Source: Has The Sirius XM Used Car Opportunity Been Over-Hyped?

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.