Sirius XM CFO Discusses Vertical Integration

| About: Sirius XM (SIRI)

In a wide ranging interview at the Deutsche Bank Leveraged Finance Conference, Sirius XM Radio (NASDAQ:SIRI) CFO was questioned about the company's new and used car opportunities, content, competition, leverage ratios, Liberty Media (NASDAQ:LMCA) ownership stake and the company's pending acquisition of the Connected Vehicle Unit [CVU] from Agero. While much of the information was already known to most investors, there were certain aspects of the Agero acquisition, as well as future acquisitions, that were interesting.

Ever since Sirius XM started reducing debt and building up cash, former CEO Mel Karmazin began discussing returning capital to shareholders. In August 2011, Karmazin stated:

With no debt to pay off next year, we continue to think we will be in a position, subject to our board deciding to do this, to return cash to shareholders sometime next year. We continue to look at acquisition opportunities as they arise. Accretive acquisitions that benefit our shareholders would be the first priority for our free cash flow, but with our criteria and threshold for acquisitions, they are hard to come by. So absent a compelling acquisition, shrinking our shares outstanding would be a great use of our free cash flow.

A few months later he said:

We are focused on growing our free cash flow substantially in the future. Free cash flow will enable us to invest in our business, which will increase growth, reward shareholders via dividends or share repurchases and make accretive acquisitions to improve the value of our company.

The modest change added dividends to the picture. Earlier this year, Jim Meyer, Karmazin's replacement, stated:

We also continue to look over selectively, I might add, at potential M&A opportunities and areas we could increase investment internally. We have always had a very high threshold for value creation when looking at acquisition opportunities and this is going to remain true going forward.

We think investing in our current business and pursuing external opportunities should they exist can both be done while maintaining a very substantial capital return program to benefit our shareholders.

Ever since the CVU acquisition was announced, I had been looking for information on the financials - revenue, earnings, free cash flow, and whether or not the acquisition would be accretive. After three executive presentations in the past month, investors are still left in the dark. One thing is clear. Investors should not expect too much over the next several years. Meyer stated:

So, I think, first and foremost, we're at the very beginning of this curve, the very, very beginning. And the thing you have to learn in the automotive business is even when you get a great idea and you want to drive it, it takes two, three, four years. So to be clear we're talking about 2017 and beyond before this is meaningful.

Unfortunately, "meaningful" is a somewhat nebulous term, and in the context of the question and the answer, investors don't know if it refers to revenue, earnings or free cash flow. Or, even if it means that the acquisition will be bleeding cash for the next several years. Frear didn't offer much more at the Deutsche Bank presentation:

It immediately gives us just a great footprint among the OEMs. So through the satellite radio side that we've been integrated with all of the OEMs and their engineering teams who are 10 years out in making their consumer electronics product working the dash and connected car is exactly that it's taking a cellular modem and make it work efficiently in the dashboard.

Frear then went on to discuss the other participants in telematics, stating that combining Sirius XM with Nissan and Agero's customers, that the company will "have relationships with 40% of North American automotive manufacturers." I believe that his words were very carefully chosen, and clearly this does not mean that Sirius XM and Agero will have 40% of the revenue following the acquisition. More on this in a moment. He continued:

  • Next largest was GM's (NYSE:GM) OnStar with "mid-teens type participation"
  • Next, Sprint (NYSE:S) service with Chrysler in "mid single digits"
  • Verizon Service (NYSE:VZ) with Mercedes and Audi, with "mid single digit"

These percentages differ somewhat from information found at The combination of Nissan, along with Honda, Toyota and Hyundai vehicle sales, is approximately 37%. GM is the leader with 18%, with Chrysler at 11.5% whether one uses a rolling 12-month or a September year-to-date number - clearly above mid single digits. The combination of Audi and Mercedes is just over 3%.

Earlier, I suggested that the percentages were not reflective of the telematics market share by revenue. It appears that it is more closely aligned with number of vehicles sold. So, how large is the telematics revenue pie?

It all depends on how broadly it is defined. Looking at just one portion, the GM OnStar business will give the investor an idea of the size. As far back as January of 2011, a Bloomberg article noted:

OnStar, which delivers safety, security and navigation features into GM cars via satellite, has 6 million customers. More than 4 million of its users are paid subscribers at $240 each, [Greg Ross, a vice president at GM's OnStar unit] said. The others are on a one-year free trial period given when consumers buy a GM car.

"It's a billion-dollar business," Ross said in an interview today at the North American International Auto Show in Detroit. "It's significant and it's going to get even more significant."

The subscribers, now also in Canada, China and Mexico, have risen to 6.5 million, and the revenues have increased significantly:

OnStar's revenue has been estimated at $1.5 billion with margins of 30 percent to 35 percent by Citi Investment Research analyst Itay Michaeli.

So, going back to Frear's comment on share, if OnStar was in the mid-teens and the CVU-Sirius XM combination was 40%, that would place the telematics revenue of the combined unit at more than $3 billion. Clearly that would be inconsistent with both Meyer's and Frear's comments about the business making a meaningful contribution in the near or medium term. And, it is not revenue, it is likely to be based on volume of vehicles sold.

OnStar Availability

Frear also said "I don't anticipate OnStar going to other OEMs." OnStar may not cut deals with other OEMs, but it is available as an after-market product for a large number of non-GM models and has been certified to work with more than 100 million vehicles sold since 2000. The technology is part of a replacement rearview mirror that costs $99, which includes installation. The subscription services are $18.95/month (or $199 per year) or $28.95/month and include:

The Safe & Sound® Plan offers a range of services with an unsurpassed level of safety and security, with live Advisors available 24 hours a day, 7 days a week: Automatic Crash Response, access to Emergency Services, Roadside Assistance, Stolen Vehicle Assistance and available Hands-Free Calling. The Directions & Connections® Plan includes all of these services, PLUS unlimited Turn-By-Turn Navigation services.

Although the OnStar service has now been available in the after-market two years, it is not clear how much of the GM revenue comes from that initiative. One piece of evidence that suggests that it may be less successful than originally anticipated can be found in the initial press release:

Available in the U.S. in spring 2011... Best Buy announced as first strategic retail partner, with over 1,100 stores; other selected retailers to follow

OnStar will offer the mirror in the United States through Best Buy, its first strategic retail partner, beginning in spring 2011. The product will also be available through other selected consumer electronics retailers.

"We're proud to be OnStar's first strategic retail partner for this innovative offering, which is one more way Best Buy can help our customers stay connected whenever and wherever they want," said Lisa Farrell, senior vice president and general manager portable electronics customer solutions group at Best Buy. "We provide a one-stop solution for consumers. In addition to purchasing the device at Best Buy, we offer our customers the convenience of having it installed by our Geek Squad Auto Techs - all at one location."

Best Buy was still on board several months later when the product was released, but two years later it is not listed as an OnStar retailer. If the product volumes met expectations, one would have expected Best Buy to still be selling the product. A look at the Best Buy web site shows no mention of the after-market FMV OnStar product. (On a related note, Best Buy still offers the Sirius XM Onyx and Onyx Plus satellite radios.) One final note about the product; the list of participating retailers/installers shows no non-GM nationwide companies participating.

Future Acquisitions By Sirius XM

Both Frear and Meyer have been asked about whether or not Sirius XM would be making future acquisitions in the telematics space. Meyer's response:

I won't say we don't need anything else, but I can also tell you, I don't see what it is today, okay. So we think Agero helps us fill, some key areas that we had to fill to be a leader in this space.

That said, there may be services or there may be things we see in the future that we think it's better to acquire than to build our selves and if so, we'll look at each one of those opportunities; I don't see it today. I think Agero takes us a major step forward in what we needed to be a leader in the connected car strategy going forward.

While Meyer answered the question based on a traditional make vs. buy decision, Frear answered a similar question just a bit differently.

You know there are not a whole lot of players to acquire right in the space and one of things you can look at doing is, you can look at going more vertical, on the space that there are some data sources that you can go out and acquire. So we certainly are looking at the vertical stack, as well as the other service providers and just sort of keeping tabs on them, but I would say there is nothing imminent.

Vertical integration, or acquiring the data providers, could make a great deal of sense, especially once a critical mass of subscribers begins to approach the ongoing cost of maintaining the data. The company would not be captive to third-party providers raising prices, or risk a telematics competitor in the space buying that provider.


The success of OnStar illustrates some of the potential revenue and profit potential in the telematics space. However, OnStar was not an overnight success story. It was started more than 16 years ago and took more than a decade to reach $1 billion in revenue.

The OEMs will be faced with similar make vs. buy decisions that Meyer discussed. Do the OEMs try to replicate the efforts of GM? Will they feel it is necessary to control the technology as some of the more advanced technologies become more tightly integrated into their vehicles? Or, will they look for a third-party cost-effective alternative?

Sirius XM's acquisition of the CVU puts together many of the same pieces that GM has already assembled with OnStar. Further vertical integration with the acquisition of data providers could help contain, or even reduce future costs. And, to the extent that other OEMs view OnStar as a significant advantage for GM, a reasonably priced CVU-Sirius XM offering could be an attractive alternative.

Disclosure: I am long SIRI, VZ. 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: 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. I have no position in the other companies mentioned in this article.