Sirius XM Disappoints Investors

Oct.25.13 | About: Sirius XM (SIRI)

Sirius XM Radio (NASDAQ:SIRI) reported results for its third quarter yesterday and issued preliminary (and partial) guidance for 2014. The numbers obviously disappointed investors as the shares are down more than 10% from highs reached earlier this week. On Tuesday, October 22nd, the shares closed at a post merger high of $4.13, and reached a post-merger intra-day high of $4.18 the following day. Following the earnings, the shares closed at $3.91, and have traded as low as $3.66 so far today and as of this writing are trading at $3.70.

How bad was the company's performance? Strangely, the performance was quite strong. It was the expectations that were too high. The company had issued guidance at the beginning of the year:

  • Revenue of over $3.7 billion
  • Adjusted EBITDA of over $1.1 billion,
  • Free cash flow approaching $900 million,
  • Self-pay net subscriber additions of approximately 1.6 million, and
  • Total net subscriber additions of approximately 1.4 million.

Periodically throughout the year the guidance was fine-tuned and at the end of Q2 it was relatively unchanged:

  • Revenue of over $3.7 billion,
  • Adjusted EBITDA of approximately $1.14 billion,
  • Free cash flow of approximately $915 million,
  • Self-pay net subscriber additions of approximately 1.6 million, and
  • Total net subscriber additions of approximately 1.5 million.

As part of yesterday's announcement, the guidance again had moderate adjustments:

  • Total net subscriber additions of approximately 1.6 million, up from previous guidance of 1.5 million,
  • Self-pay net subscriber additions of approximately 1.5 million, down from previous guidance of approximately 1.6 million,
  • Revenue of approximately $3.77 billion, up from previous guidance of over $3.7 billion,
  • Adjusted EBITDA of approximately $1.14 billion, and
  • Free cash flow of approximately $915 million.

The metric that I choose to focus on is free cash flow, and that hasn't really changed. The free cash flow is what will be used to fund the share buybacks, acquisitions or dividends. It depends mostly on subscribers being willing to pay the monthly subscription fees, and to a lesser extent, on some of the OEMs that pay for new car buyers to have a trial subscription. Those paid trials will now be 100,000 higher and self-pay subscribers will be 100,000 lower to start 2014.

So, what spooked investors? Was it the change in net self pay subscriber additions? Here's what CEO Jim Meyer said about subscribers on the conference call:

We have seen that our existing new car subscribers are turning over their vehicles sooner than what would have been predicted based on historical industry trends. As a result, our subscribers are migrating from one radio to another in a newer car. This trend picked up in the third quarter and is ahead of our expectations and this trend of faster turnover is good for the business long-term as it leads to increased opportunities for used car subscriptions, but we are now estimating self-pay net adds of approximately 1.5 million for 2013.

Self-pay net adds are a key to the future growth of Sirius XM, and the fact that the company will have fewer of them to start the year presents a small problem. This has to do with the future de-activations which come from two sources - self-pay subscribers that choose not to renew (called churn, or approximately 22%) and paid promotional subscribers that do not convert to self-pay subscribers at the end of the trial (1 - the conversion rate, or 56%). Although the change is small, it does indicate that management now sees fewer than expected subscribers that are willing to pay. And if, as Meyer reports, self-pay subscribers are turning their cars over more quickly, it means that Sirius XM will be getting reduced or zero subscriber fees for a period of three or more months when these satisfied self-pay subscribers become new car owners.

In spite of this, the company still "increased" revenue guidance for the year, although it is debatable if this is an increase. The change from "more than $3.7 billion" to more than $3.77 billion" is only an increase if one is rounding the numbers to the nearest $0.1 billion. Investors should also consider this: Although the revenue has been increased by $70 million in the most recent guidance, the free cash flow remained at $915 million.

The Sirius XM subscription model has been quite predictable for the past few years, and investors have come to expect that management would issue conservative guidance and then beat the numbers. The revenue over the past few years has come in a few percentage points above guidance, while free cash flow and the number of subscribers would beat guidance by larger amounts.

Unfortunately, the analysts used Sirius XM's guidance as base line figures and then built models and made recommendations based on the company beating that guidance. Now that guidance is looking fairly accurate, there have been downgrades by Goldman Sachs and Evercore Partners.

2014 Guidance

Additionally, preliminary guidance for 2014 was issued by Sirius XM:

  • Revenue of over $4.0 billion, and
  • Adjusted EBITDA of approximately $1.38 billion.

These figures are surprisingly low. Considering that Sirius XM has launched a low cost subscription option targeted to the Hispanic market, that it will have acquired a new business - the Connected Vehicle Unit - from Agero, and is increasing the monthly subscription fee for many subscribers by $0.50/month, why is revenue increasing by such a small amount?

Analysts and investors will need to decide if the comapny is issuing guidance for 2014 that is even more conservative than normal, or if the company is giving an accurate assessment.

Liberty Media

As most investors know, Liberty Media (NASDAQ:LMCA) is the majority owner of Sirius XM, and Liberty's president and CEO, Greg Maffei, is the Chairman of Sirius XM. Recently Liberty entered into a $500 million share purchase agreement with Sirius XM. The price Liberty will receive will be a discount of 1.5% from:

...the average of the daily volume weighted average price ("VWAP") per share of the [Sirius] Common Stock during the ten-day period beginning on the third trading day following the date of the public release of our third quarter 2013 earnings.

The VWAP will have an upper boundary of $4.18 and a lower boundary of $3.64. Did Liberty know something that the rest of investors did not? It's a remarkable coincident that the price of the shares peaked at $4.18 early in the week and traded as low as $3.66 today.

While Liberty is an insider, and some Sirius investors consider it a strong plus that its Chairman John Malone is interested in the performance of Sirius XM, I doubt even he expected the boundary prices to be so close to the highs and lows of the share prices so far this week.

Summary

Sirius XM issued an earnings report and year-end guidance that is remarkably consistent with previous 2013 guidance with the exception of the mix of self-pay and paid promotional subscribers. It is clear that the company will set post merger records for total subscribers, revenue, EBITDA and free cash flow, beating the previous highs by substantial amounts.

The performance this year just won't be enough to satisfy many investors or a market which had expected so much more. As to 2014, I expect Sirius XM to exceed guidance. The only issue will be how much is already built into the price of the shares.

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: 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.