Sirius XM Holdings (SIRI) got its start by providing subscribers the opportunity to listen to commercial free music in return for charging a monthly fee. The satellite service also provided a wider selection of listening choices and better reception than was available in many areas. A few years ago the company celebrated passing the 20 million subscriber mark by hosting a live concert at the famous Apollo Theater in NY featuring former Beatle, Paul McCartney. On Sunday night there was a special tribute celebrating the 50th anniversary of The Beatles arrival in America and their first appearance on the Ed Sullivan Show, including performances by surviving Beatles members, McCartney and Ringo Starr.
While the sweet music has endured, and can still be listened to on Sirius XM, the company's results issued last week hit some sour notes with investors and analysts. Wunderlich Securities downgraded the stock from buy to hold, and the share price had drifted lower since earnings were released. Did the results deliver less than expected?
It's not clear what analysts were expecting that hadn't been pre-announced. The company had announced that it would miss its Self-pay Subscriber guidance months ago, missing the 1.6 million net add figure by 88,457 subscribers. Most other reported figures came in at levels that should have been expected, especially those that related to significant events in the fourth quarter.
Major Changes in Q4
Several significant events occurred in Q4. The first was a change with one of its major OEM partners. The second was the completion of the acquisition of the Connected Vehicle Services business from Agero. The third was the early redemption of the company's 7.625% debt. All were known ahead of time and should not have come as a surprise.
For more than a year Sirius XM had been telegraphing that there would be a shift by one of its OEM partners, widely believed to be General Motors (GM). That change would result in the OEM paying Sirius XM a fee for each trial that it provided end users to one where the trials would become free to the OEM. Sirius XM would still provide subsidies to the OEM to install the radios, but the revenue sharing - should the radio subsequently generate self-pay subscriber revenue - between the parties would be reduced. This change would impact several fourth quarter numbers, including:
- Total subscribers
- Average Revenue Per User, or ARPU
- Free Cash Flow
These components interact with each other, in some cases driving a metric higher while in other cases reducing the figures. Clearly, losing the paid promotional subscribers reduces both that category as well as total subscribers. That was apparent as paid promotional subscribers for Q4 dropped by 434,240 (or 9%) from 4,911,733 to 4,477,493. It also showed up as the total reported subscribers - self-pay subscribers and paid promotional subscribers - declined by 22,756. This was the first time total subscribers had declined since Q2 2009 when the country was still in the depths of the recession.
In terms of revenue and free cash flow, the change would also be negative. However, the combination of reduced revenue and reduced subscribers would have a positive effect on ARPU. This is because (1) the monthly subscription fee that the OEM paid for promotional subscribers is almost certainly below the average paid by self-pay subscribers, and (2) the non-subscription revenue will be spread over a relatively lower number of subscribers.
Curiously, the notations in the 10-K that discussed the changes in subscriber revenue during 2013 compared to 2012 made no mention of the loss of the paid promotional revenue,
These increases were partially offset by subscription discounts offered through customer acquisition and retention programs, and an increasing number of lifetime subscription plans that have reached full revenue recognition.
although it did note the positive benefit of the acquisition from Agero.
Closing on Purchase from Agero
The purchase from Agero used $530 million of cash and may have produced $10-$15 million in revenue. Unfortunately, the company does not break out the Connected Vehicle Service revenue in the income statement, but includes it in the Subscriber Revenue line item. From the 10-K:
For the years ended December 31, 2013 and 2012, subscriber revenue was $3,284,660 and $2,962,665, respectively, an increase of 11%, or $321,995. The increase was primarily attributable to a 9% increase in the daily weighted average number of subscribers, the impact of the increase in certain of our subscription rates beginning in January 2012 as more subscribers migrated to the higher rates, and an increase in subscriptions to premium services, premier channels and Internet streaming, as well as the inclusion of connected vehicle subscription revenue in 2013.
The $10-$15 million estimate is based on the following pieces of information. In a press release dated November 4th, Sirius XM announced, "...it has completed the previously announced acquisition of the connected vehicle services business of Agero, Inc." And, during the Q4 conference call, Sirius XM CFO David Frear said:
In 2014, we expect connected vehicle services, excluding our existing traffic business, to approach $100 million in revenue. In the course of the next three years, we expect connected vehicle service revenue will double, and will continue to grow at high rates for many years to come.
Assuming the revenue comes in evenly over the year, then 2 months would be $16.7 million. Since the revenue is expected to grow rapidly over the next three years, it has been assumed that it will be growing in 2014 and was running well below the $100 million annual rate during Q4. (No mention was made about the increased costs associated with the acquisition.)
Early Redemption of 7.625% Debt
As expected, the 7.625% redemption required a cash payment of approximately $60 million for the make whole provision on the early call, in addition to the $540 million for the principal amount. Aside from the impact on the cash balance, there was a one-time pre-tax charge to earnings of $65 million for the early extinguishment of debt.
ARPU finished 2012 at a run rate of $12.12. By the end of Q3 2013, it had increased to $12.23, or less than 1%. Compared to prior quarterly increases, ARPU was up significantly in Q4, as it rose $0.23 or 1.8% from the prior quarter.
As noted above, the OEM shift would have contributed a portion of this increase, but there are also additional factors that contributed. These would include a small increase in net advertising revenue, the increase in revenue resulting from the acquisition from Agero, and the increase in the Music Royalty Fee.
The MRF increase may have had one of the larger impacts. It is included in "Other revenue," a category that increased by 29% from Q4 2012.
Liberty Media Overhang
Overhanging the market for Sirius XM shares is the proposal by Liberty Media (LMCA) to exchange .076 non-voting shares of a new series of stock in Liberty for each share of Sirius XM it does not already own. Sirius XM has named a special committee to evaluate the proposal, and as yet no statement has been released about that evaluation.
In a related move, Charter Communications (CHTR), a company 27% owned by Liberty Media, is preparing for a hostile takeover of Time Warner Cable (TWC). It has submitted a full slate of independent directors as nominees for the board of Time Warner. It is widely expected that Liberty Media will be providing some of the funding for the potential takeover, and that it expects to use its Sirius XM asset as a source for some of that funding.
Most of the negative news about Sirius XM had been pre-announced and should not have been a surprise. And, if the weakness in self-pay net adds or the one time debt retirement charge should have been expected, then a solid increase in ARPU should have provided a bright spot in the year-end report.
It's possible that analysts and investors were looking for much more information on the status of the Liberty Media proposed share exchange and were disappointed by a lack of new information. Or perhaps they were expecting more detail on the acquisition from Agero. Regardless of the reasons, since the earnings were released, the shares traded as low as $3.35, down more than 9% from the day before the release. They have finally climbed back to that $3.58 level. Where the shares head from here will probably depend more on the recommendation of the independent directors than the business prospects at Sirius XM.
Additional disclosure: I actively trade SIRI. In addition to my long positions in SIRI, I have January 2015 $4 covered calls written against two of these positions. I may initiate new covered call positions or close out or open new positions in SIRI or LMCA at any time.