If You Believe Sirius Is Overvalued, Think Again

| About: Sirius XM (SIRI)

It sounds trite to say, but there's never a dull moment in the land of Sirius XM (NASDAQ:SIRI). Our recent articles, which outlined scenarios where both Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) might be interested in the satellite radio giant, have caused quite the stir. With shares having reached a five-year high of $3.59 last week and resting at $3.54 (as of this writing), there is now notions that Sirius XM has grown too expensive. I disagree.

While we won't argue that this recent rise presents opportunities for investors to secure profits, there is ample evidence that more gains are on the way. I'm not going to sit here and pretend to know where the stock is heading - nobody really does. However, what we do know is that Sirius is operating on all cylinders. And with a few improvements along the way, $4.00 per share is not only a reality, but it will eventually serve as Sirius' new floor. It's all psychological.

The higher the stock goes, the cheaper it looks

There's no way that this makes sense, right? How is it possible that a stock can get cheaper the higher it goes? I think investors often get too enamored with prices and targets and lose sight of what these valuations may mean. Sirius can go higher and still not reach "overbought" levels - at least not yet because as Sirius goes up, it progressively loses the stigma of being a penny stock.

In fact, I will argue that this dubious distinction was lost as soon a Liberty Media (NASDAQ:LMCA) seized majority control. The Street values the stability that Liberty has brought. That, along with Sirius actively buying back its stock demonstrates not only the value that the company sees in its equity, but the fact that Sirius is doing so at a rate commensurate to its ability to produce cash, which is close to $1 billion in operating cash flow, speaks to the effectiveness of the company's subscription business model.

However, and more importantly, here's what investors have to consider; there are institutions that would love to own shares of Sirius by virtue of Liberty's ownership, which is owned by Warren Buffet. What this means is that as Sirius creeps up in share price, (let's say) $4.00 per share, which is possible by this summer, the stock will be on the radar of several large funds (if it's not already) since shares will then be just 25% away from $5.00.

Once Sirius gets to $5.00, you can expect the stock to appreciate faster as earnings-per-share begin to rise with less of the float available by virtue of the buyback program. But several institutions are prohibited from buying sub-$5.00 stocks. As soon as that barrier is broken, $5.00 can then become the "new floor." You see how this works? There's the staircase effect bringing "higher highs and higher lows." As I've said, it's psychological.

I've read comments where investors have said they've been holding since the stock was at $7.00. That target may seem far away, but at this point, it's closer than you might think. In that regard, if you wonder that we are getting ahead of ourselves, we're not.

Investors should be asking themselves if they are prepared to make these important buy/hold/sell decisions when the stock begins to rise. If it surprises you that I used the word "begin" to describe a stock that has already posted 20% year-to-date gains, it was not by accident. And I believe Sirius will begin to do its part to realize these sorts of gains.

Catalyst for more gains

Given the recent improvements in Sirius' fundamentals, I don't believe that the market has fully priced in the fact that Sirius might have (again) low-balled guidance as the company is known to do. The company is outperforming in several important categories and its 11.5% revenue growth more than doubles the industry average of 4.7%.

What this tells me, though, is that Sirius will raise prices at some point in the next twelve months. My guess is that an announcement regarding a price hike can be expected sometime in the third or fourth quarter. With Sirius' recent victory over SoundExchange, I think it's time. As impressive as Sirius' growth has been over the past couple of years, I would love to see more growth on the bottom line - as would the Street. I think management understands this.

If the company wants to continue rewarding investors with excellent returns on equity as it has done over the past year, a price hike has to occur. It's no coincidence that since Sirius raised prices in January of 2012, the stock has almost doubled - soaring 97%. This is even though the price increase has yet to reach every subscriber. If Sirius raises prices as I expect it to do in January 2014, the Stock will reach $5.00 by May of that year. Then the floodgates open.

Bottom Line

Sirius continues to be an incredible story. There was a point when I spent most of last year beating on management for some poor decisions. However, today, I almost don't recognize this company for how much is has improved. That said, there is still plenty of work to be done. The good news is that this current management team is doing better job managing expectations while also executing the company's objectives. With the 20% YTD gains notwithstanding, Sirius still presents considerable value from this level.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.