Sirius XM: It Isn't That Confusing

| About: Sirius XM (SIRI)

I'm a bit perplexed when reading some articles surrounding my investments. While I tend to hold a basket of stocks which some may consider lacking in variety, I do read every bit of information I can on each and every one of them. My largest holding, and currently my only holding is Sirius XM (NASDAQ:SIRI) and it certainly has not been immune from some of the confusion which has permeated opinions on the company over the years.

I find my investment choice in Sirius XM to be a simple story of good company performance and growth, as evidenced by its earnings reports. Some of the most recent data can be seen within the slideshow presented at the 2013 shareholder meeting. Couple this with a dominant position in new car dashboards, an exclusive delivery system by satellite, and the flexibility to incorporate itself into the connected car as it becomes more widespread. Toss in a $2 billion share buyback which I expect to at least double to $4 billion, for good measure, and it's a winner.

So why do I have so much trouble when reading articles such as the most recent one posted by Stocksaints? Why can't I just nod my head instead of scratching it? It's a bullish article, right?

I guess. But it's full of vague assumptions and errors that I feel should be addressed, as I believe they do more harm than good.

First off, the entire article is based around the notion that the market has gotten Sirius XM wrong. We all know stocks go up and down. We all know stocks will trade above and below what the other guy considers fair value. But it's also unreasonable to think that the market is getting Sirius XM wrong simply because the stock has doubled over the past year when measured from its extreme low to its extreme high.

there have been several mistakes along the way made by Street analysts, including under-projecting the rise in auto sales and an improved consumer spending environment.

I just don't see this as the case. One can cherry pick an analyst that may have gotten his or her projection wrong, but the fact of the matter is that analysts such as John Tinker have come pretty darn close to the mark. He's a sharp guy and I'd be lying if I did not say it gives me some comfort to see his $4.20 target for this year considering my own at $4.25 which I issued at the onset of 2013. I'm not trying to pat myself on the back here (or maybe I am?) but I began 2012 with a $2.75 projection for Sirius XM, which I later upped to $3 as Sirius XM increased subscriber guidance. Both targets were hit.

Do I work for a big firm? No. I'm an investor with an opinion, but I make up "the street" the same as John Tinker and the same as any other individual. Together all investors make up "the market" and I'd argue that the market is doing a fine job of pricing Sirius XM. Speculation can and will drive the price up and down but for the most part I find Sirius XM to be just about where I would expect it to be given a straight line of appreciation from year's open at $3 a share, to my expectation of $4.25 sometime before January 2014 option expiration.

Is it a question of valuation?

Stocksaints makes the following argument:

However, investors have to understand why these metrics are so important and why I believe Sirius is still undervalued. What's beginning to stir the pot is Sirius' ongoing share buyback program. The Street has not adequately adjusted their models to factor in the effect of a reduced float. This throws off their enterprise value (NYSE:EV) and EBITDA calculations. This is why I've argued that $4.00 per share is more realistic sometime in the third quarter.

For those who are unfamiliar, the market has historically priced SIRI by taking into account Sirius' EV and dividing that number by the company's EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation and Amortization. To understand how to arrive at the enterprise value, you take Sirius' debt and then add in the amount of the float outstanding, while adjusting out the cash. You then take that number and divide it by the EBITDA. There's nothing wrong with this equation.

Let's break this down a little here.

Sirius XM is often modeled under a multiple valuation of EV (enterprise value) divided by EBITDA. How does a buyback change the multiple? It raises it, and that doesn't improve the case for valuation using this ratio. EBITDA is not affected, but EV takes market cap, plus debt, minus cash. It's the numerator in the equation and by spending cash to retire shares, adding to debt to retire shares, or with a share price that increases, the numerator also increases. This increases your multiple.

There's nothing wrong with this equation, that's correct, but investors need to understand that a buyback does not throw off any calculations. The benefits of the buyback are contained within the expected future appreciation of Sirius XM's share price compared to the cost of the debt taken on to repurchase the shares. Because of this, Sirius XM based on future projections may in fact be able to tolerate a higher multiple today. That's where the benefit is. The fact that Sirius XM is investing in itself, and could essentially double what it spends today within 5 or 6 years, adds future value. But as far as that EV/EBITDA multiple today, it doesn't shrink that multiple at all.

Can I disagree more?

But here's the problem; the market has only been focusing on what Sirius has reported. While there's nothing wrong with that, it doesn't always reflect Sirius' real value, especially when the market fails to understand that Sirius will outperform its guidance. This is why the stock has been consistently going up. Essentially, "the market has been correcting its error upwards." This is the opposite of the downward correction - hence why the stock has doubled over the past year, while outperforming all the major indexes.

Again, I hate to do this but I wholeheartedly disagree here. I believe that savvy investors, "the market," understand quite well that Sirius XM tends to guide conservatively and thus under promise and over deliver. I know I have stated it many times myself, and even some notable bears have used this argument over the years as something which is predictable when it comes to Sirius XM.

So why has the stock been going up? For one, yes, the company has performed well. But to simplify it so greatly completely ignores the impact from Liberty Media's (NASDAQ:LMCA) pursuit of control during which it spent well over a billion dollars in the open market for stock to bring its stake beyond 50%. Throw in a special dividend at the end of the year, and add in the impact of additional purchases by Sirius XM under its buyback program as well. There's more going on here than simple market correction. A lot more.

The bottom line?

I can't disagree with Stocksaints' recommendation to buy Sirius XM, and I certainly do not disagree with everything that is said in their most recent articles. But I think Stocksaints is actually getting a bit too bullish here and may wish to consider slowing down a bit and really digging into what has been driving Sirius XM's share price for nearly a year now. With my only investment right now being Sirius XM, I'd be thrilled if the share price would shoot the moon quickly to those rosy numbers such as $5 per share, but I just don't see it happening. I think the market has Sirius XM priced in relatively fair territory based on current known data.

That may all change once share counts are updated in Sirius XM's Q2 call, but that is at least two months away. Until then, I believe $3.75 is the upper bound and will present a struggle without any surprise news.

Disclosure: I am long SIRI. 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.

Additional disclosure: I am long SIRI January 2014 $2 and $2.50 calls. I may sell part or all of my position in order to make other short term trades in early June.