During an interview at the Deutsche Bank Leveraged Finance Conference, Sirius XM Radio (SIRI) CFO David Frear was questioned about the company's pending acquisition, new and used car opportunities, content, competition, leverage ratios, and the Liberty Media (LMCA) ownership stake. While much of the information was already known to most investors, there were certain items that were new, interesting or worth repeating. One of these, the acquisition from Agero, was discussed in a previous article.
New and Used Cars
Frear added relatively little in the way of new information about the new or used vehicle opportunity and repeated much of the same information that has been repeated for more than a year. The new car penetration rate will remain in the high 60% range and the used car opportunity would eventually be comprised of a large portion of a future installed base of 150 million OEM-equipped vehicles. On the new car front, he also discussed that the process was still underway to attempt to migrate all the OEMs to the XM platform, although the company still had "... a few more left to go in the next sort of four years."
Migrating OEMs to a Single Platform
Moving all the OEMs to a single platform should reduce hardware costs, could eventually pave the way to broadcasting to a single platform and free up valuable spectrum. Frear had discussed this in the past (see The Hidden Asset of Sirius XM), and with an emphasis on signing up second owners, he pointed out that it would be quite a while before broadcasting to a single platform could take place:
...you have to think about it as like the analog to digital conversion that there will still be those legacy Sirius only vehicles that are out there for a long time. It will be middle of the next decade before they get down to a level that which we could say that what we don't need to uplink the 70s channel twice anymore and we can expand the program and it could be more audio, it could be more data, it could be video, it could be a lot of things, but it's a next decade issue.
It should also be remembered that cars are remaining on the road for a very long time. The average age of vehicles on the road is up to 11.4 years. They are remaining on the road not only because of a slowly recovering economy, but also because cars are simply made better. This suggests that there will be a significant number of Sirius platform receivers still on the road in the next decade.
These older cars would still represent part of the used car opportunity that Frear referred to, and may even still be held by original owners that are subscribers. Would it make sense for Sirius XM to eliminate broadcasting over the Sirius spectrum? At some point it should, but it is a decision that is a decade away and shouldn't represent significant value in today's dollars. Also, one of the conditions of the merger between Sirius and XM was that the merged company would continue to broadcast on both platforms, so Sirius XM would need the FCC, and perhaps the FTC, to grant a waiver for the company to be permitted to broadcast to a single platform.
The content costs have declined significantly at Sirius XM since the merger. Frear said:
So just before we merge that the two companies were spending about $400 million a year on programming, and it's now down to just a little under $300 million. It's an unusual pattern for programming cost in media in the United States. But it speaks volumes as about the inefficiencies of the two companies being separately, efficiencies have been together.
I think that are - we still expect programming cost to come down slightly from where they are now, but we really have now sort of gotten through, I think all of the - all of the big deals. and so I wouldn't expect any material declines in programming cost from here in the absence of a major piece of content leaving the platform.
Note that Frear states that most of the cost savings have been realized and that he only expects them to decline slightly, with the exception being a major piece of content leaving the platform. A major piece of the content expense is Howard Stern whose contract comes up for renewal at the end of 2015. Frear stated:
Well, Howard is a unique talent in radio. I mean there has never been anybody like him and never will be, right? And he puts on a fantastic show. He works hard. He's a great partner - just we can be happier with relationship that we've had with Howard. It's like any great performer, there is going to come a day when he decides to step off the competitive stage, and I hope that day is much later rather than sooner. I don't know what he we will decide to do when his contract is up. I know that we'd like to keep him on our air and performing for as long as he'd like to do that.
One of the costs not addressed in the discussion of the $300 million was the music royalty. Barring Congress legislating any changes - and considering how dysfunctional Congress has become, that seems unlikely - this cost should be rising over the next 5 years as both the royalty percentage and the revenue against which the percentage is assessed will increase. In a related discussion about competition and content costs, Frear talked about Pandora Media (P) and its costs.
When the interviewer stated,
...as I think about what [Pandora is] trying to do and others, the cost of doing it in a digital world is prohibitive in a lot of cases and you mentioned that particular case. Can you talk about your…
Well, it's not that a cost is prohibitive in the digital world, but monetization is so uncertain in the digital world… And so a good example, Pandora monetizes roughly at $6.50 a year, okay, per listener. ... Okay. Then we have Internet listeners and we're charging a little over $3 a month. So we are monetising at $36 a year. So if you took the 60% royalty load that they have under $6 and put it on our $36, it's 10%, right, and our people are listening to a mix of music, talk, news and sports. So it's probably a little less than 10% for us, because of the mix. So it's not really about the costs, all right. So Pandora's costs, the rest of digital guys, for instance, are significantly less than what we pay and what Clear Channel pays, all right. It's 40% less on the rates, but they got to monetize to have those costs to be reasonable.
Clearly Frear didn't want to be endorsing a position that Pandora is facing prohibitive costs. And certainly not when Pandora is pushing for Congressional action on the IP royalty front.
Frear discussed another aspect about Pandora during the questions about competition, still citing terrestrial radio as the dominant competitor. While discussing the history of the audio input jack in a car dashboard - first with an iPod and then with smartphones - he said:
So - but in the last four years, with a 140 million smartphones hitting the street, we haven't really seen a perceptible change in demand for our service.
So I think in the future, if you then move to next step, right, that you're saying okay, maybe you can say that, gee, it's sort of clunky to take the smartphone and try and use its screen to control what's playing through your dashboard and they're going to put it in the dashboard and it's going to be up on the screen there and then you're going to have some kind of a user interface that's going to allow you to select channels and the question is what's the product, because the customer definitely doesn't really care about the technology. What they care about is the content, what are they doing with that, are they listening to music, are they getting news, are they getting sports.
With the "clunky" part removed from the equation, does Frear consider Pandora a threat? Not exactly...
I take my hat off to Pandora, 70 million listeners is absolutely huge. The fact that they are not monetizing is a different issue, but they've done a great job amassing the audience.
He went on to discuss all the advantages Sirius had with content, concluding:
And so I think it actually sets us up to compete better against what I will acknowledge is going to be a very competitive landscape.
Liberty Media owns a majority stake in Sirius XM and controls its board of directors. Anytime that Liberty CEO Greg Maffei or a Sirius XM executive is available for questions, it always seems that a question about Liberty's intentions comes up. It was no different in this interview. Frear stated that he knew as little as anyone else about what Liberty would do...
I really only know what I read, right. and so Liberty has said that they spent about $1.7 billion going from 40% to 51%, they've said they would like to get that money back. I believe they'd probably do. And they've also said that they see Sirius XM being an independent company at some point in time, but the question is, in what way and in what timeframe and I really don't know anything more than that.
During a Goldman Sachs interview with Sirius Chairman and Liberty CEO, Greg Maffei, the same issue came up in a different context. Earlier this year, Liberty acquired a significant stake in Charter Communications, with some of the funds coming from a margin loan partially secured by Sirius XM stock. Liberty has the opportunity to grow that stake, although at the current time is somewhat constrained by the availability of cash.
Noting that Liberty had $1.1 billion of margin debt with an 18 month maturity and only $350 million of cash, Maffei said the following:
At some point, we will either, through dividends up from Sirius or sales of Sirius or some other longer term refinancing mechanism, reduce that margin debt.
This was not the first time that Maffei discussed Liberty selling shares back to Sirius XM. He has often talked about Liberty eventually getting back the money spent on taking Liberty's ownership from 40% to majority and did so again during this interview. However, the idea of using a dividend was an interesting revelation.
Either way, there are implications with respect to a share buyback. If a dividend is paid, it would need to be paid to all shareholders, and would certainly slow down the anticipated pace of a Sirius XM share buyback. And, if Liberty starts selling their shares back to Sirius XM, that would serve to reduce the buying pressure that the current buyback places on outstanding shares.
While the recent interviews do not add much in the way of Earth-shattering revelations, some themes were again reiterated and others had modifications.
- The used car opportunity represents an opportunity to monetize a large installed base of inactive Sirius XM receivers, although it could also be an impediment to freeing up spectrum.
- Liberty's margin loan has a limited duration, and it is likely that it will be paid off with funds coming from Sirius XM. Those funds will be unavailable for open market share repurchases.
- It appears that most of the savings from reduced content costs have been realized. And, this is despite renewals with Fox and MLB that many thought would reduce content costs.
Later this week, Sirius XM CEO Jim Meyer will present at the Liberty Media Investor Day before the market opens, and two weeks later Sirius XM will announce third quarter earnings. While I don't expect much at the Liberty event because of the quiet period restrictions, the company could surprise investors and issue a press release before Meyer speaks, just as it did earlier this year prior to a Frear presentation.
Between the government shutdown, executive presentations, debt ceiling debates and earnings, investors will have plenty to stay on top of during the next few weeks.
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.