Sirius XM (SIRI) will release its Q3 2013 earnings on October 24th. Given the continued strength in U.S. car sales, we expect the company’s net subscriber additions to remain strong during the quarter. Although Sirius XM has been pursuing the used-car market, its business is still largely tied up with the level of new car sales. Additionally, given that the new pricing has been rolled out completely, we expect strong revenue growth accompanied by operating leverage gain which will positively impact the margins.
Sirius XM has been an incredible success story so far but the competitive landscape might change with Apple (AAPL) and Pandora (P) pursuing the in-vehicle radio market. Our price estimate for Sirius XM stands $3.20, implying a discount of about 20% to the market price.
Sirius XM’s Will Find Support From The Continued Strength In The U.S. Automotive Market
The overall U.S. auto sales grew by roughly 8% in the third quarter of 2013 despite a slowdown in September. For the month of June, the figure jumped 9.2% amounting to 1.4 million units.  This growth was the highest the industry has seen in the last five years and stood notably above the figure for the first half of the year. August was even better with vehicle sales surging by 17%  However, September saw a slowdown as sales fell by 4.2% according to the data available with the Wall Street Journal.
How The Market Grew In The First Half Of 2013?
U.S. car buyers purchased roughly 1.4 million cars and light trucks in June bringing the half year new vehicle sales to about 7.8 million.  This implies growth of roughly 7.7% over the first half of 2012 which suggests that the U.S. automotive industry could see another record year as sales continue to climb since the recession of 2008-2009. Vehicle sales for Q1 2013 reached about 3.7 million, implying growth of roughly 7% over the first quarter of 2012. However, this growth accelerated slightly in the second quarter with June sales increasing by more than 9% over the same period last year.  Sirius XM stated during its Q2 2013 earnings announcement that vehicle sales in the U.S. could reach 15.5 million this year thanks to the gradual improvement in the economy and better financing deals.
Margins Will Show Improvement
Sirius XM’s topline growth hasn’t come at the expense of its margins, thanks to the popularity of its subscription model. This is one of the reasons why the stock has gone up significantly this year. The company’s price increases have been well-received and the content quality and variety keep customers interested. This has helped Sirius XM manage its content costs much more efficiently than other radio services operators such as Pandora. We expect this trend to continue in the third quarter.
Sirius XM’s overall content costs, which include revenue sharing & royalty costs as well as programming & content costs, account for about 37% of its total operating expenses. As a percentage of revenues, these costs declined from 31% in 2009 to 28% in 2012. For the first half of 2013, the figure maintained the level of 28%. This may be surprising given that the royalty rates for music increased each of these years, which is primarily the reason why Sirius XM’s competitor Pandora is still making losses. However, unlike Pandora, Sirius XM can afford a wide variety of content including talk shows and sports programming due to its subscription-based business model. We believe that the company has done well in terms of saving money on these content agreements due to its strong negotiating power and the absence of a central body governing the rates. After the merger of Sirius and XM, the company started reducing duplicate programming and has renewed or replaced expiring agreements on more cost effective terms.
Sirius XM’s subscriber acquisition costs primarily include hardware subsidies paid to radio manufacturers, distributors and automakers, device royalties for certain radios and chip sets, commissions paid to automakers and product warranty obligations. As a percentage of revenues, these costs have been declining and we expect the trend to continue in Q3. As the brand value increases and the service becomes popular among customers and original equipment manufacturers, Sirius XM will need to pay less commissions and subsidies.
- U.S. Car Sales Pace Hits Five Year High, The Wall Street Journal, July 2 2013
- Robust auto sales keep economy on steady growth path, Reuters, Sept 4 2013
Disclosure: No positions