Sirius XM Needs To Raise Prices

| About: Sirius XM (SIRI)

There was a point when people were calling the idea of paying for radio "foolish." This made the prospects of (then) Sirius Satellite Radio (NASDAQ:SIRI) and rival XM Satellite Radio very grim. The value proposition of premium radio wasn't considered compelling enough to entice listeners to want to shell out cash for something they could get for free. But things have changed.

Realizing they were at the mercy of a "grudge-holding" music industry, one where they were paying a ransom in royalty fees, the two satellite radio rivals united to form Sirius XM. And after a couple of years of "hiccups" and flirtation with bankruptcy, Sirius XM is now the dominant name in premium audio entertainment.

With the radio market booming and demonstrating demanding for more sounds, I believe now is the time for Sirius XM to consider another rate hike. And consumers will gladly pay for it - just ask Google (NASDAQ:GOOG), which just announced a music service of its own. And Apple (NASDAQ:AAPL) is expected to announce a competing service as early as next month when the tech giant hosts its annual Worldwide Developers Conference (WWDC).

Here's what you have to realize; companies don't enter markets that they don't believe are viable - even if it's overcrowded. In fact, that they see such a tremendous growth opportunity in the radio market is reason enough for Sirius to preemptively raise rates now. Last week, I brought up a few scenarios where I felt Sirius was due for another rate hike.

Now, on the heels of Pandora's (NYSE:P) impressive earnings results, which revealed that the company has now amassed 2.5 million paying subscribers, I can't imagine a better time for Sirius to squeeze a few more pennies from its base of 20 million self-pay subs. Let's think about this for a moment; Pandora is known for its uncanny ability to attract "free-loaders." Yet, there are now 2.5 million people that say they prefer a premium offering without ads.

An ad-free premium service has been Sirius' value proposition. If Pandora is able to generate this level of subscriber growth, Sirius should pounce on this level of demand and not think twice. The obvious question here is can Sirius survive another price hike? After all, it's been less than one year since the company instituted its price increase from $12.95 to $14.49 (up $1.54). But I see it another way - Sirius can't afford to not raise rates, especially with Pandora doing so well.

With Apple and Google entering the mix, Sirius will want to continue investing in its platform so that it can continue to differentiate itself by delivering the best audio content that it can. Doing this is going to cost money. Plus, from Sirius' first-quarter earnings report, there were signs that not only can the company survive a rate hike, but a rate hike is imminent.

For example, we know very well that Sirius posted an overall subscriber growth of 9%. In this environment, this is no small accomplishment. But self-pay subs grew at less than 2%. This is what made Pandora's ability to add 700 thousand net new subscribers in its first quarter so incredible. It represented 114% year-over-year growth.

While Pandora is outperforming Sirius in this area, Sirius dominates Pandora in every other metric, including free-cash-flow, which jumped to $142 million and is now outgrowing every segment of the business. But here's the thing; while Sirius was able to advance cash flow by lowering subscriber acquisition costs (SAC), which improved despite a 16% increase in gross subscriber additions, Sirius posted a sequential decline in ARPU, or average revenue per user.

While ARPU is still up more than 2% year over year, the fact that it dropped quarter-over-quarter does not bode well for confidence. Admittedly, it's a small number, yes. But Sirius needs better margins to maintain its cash flow levels, which pays for not only the content, but also the company's current share buyback program.

The question now is, how much of an increase would be appropriate. The last increase was $1.54. I don't think Sirius will want to get into the habit of raising rates ever two years, so this increase should be meaningful enough to account for (among other things) inflation and other costs such as royalties, debt reduction and long-term G&A expenses. Plus, this will help offset weakness in ARPU, which the company can use to spend on content to get that metric back up. Accordingly, I believe $2.00 would be a nice round number.

Bottom Line

Contrary to popular opinion, a rate increase will not cause mass subscriber defections. Sirius has proven that it can effectively utilize the cash infusion to invest back in the business and grow more subscribers, which has greatly benefited shareholders as the stock has almost doubled since the company's last price increase. At this point, it's not a matter of "if" Sirius will announce another base price increase - it's a matter of "when."

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.

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Tagged: , Broadcasting - Radio
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