Sirius Is A Buy Regardless Of Liberty's Acquisition Failure

Mar.17.14 | About: Sirius XM (SIRI)


Sirius is the market leader in car radio service, and it's now looking to gain a presence in mobile.

It has already inked deals with Toyota and Honda, extended a deal with Nissan, and plans to make a move into the used market.

With its impressive free cash flow margins and top line expansion opportunities, fair value could be over $4.

After a generally weak performance in 2013, Sirius XM (NASDAQ:SIRI) looks as if it is set to perform much better in 2014, especially if the better-than-expected fourth quarter results are anything to go by. It is now focused on consistent business growth and trying to build its business to stay ahead of rivals, such as Apple (NASDAQ:AAPL) and Spotify.

Growth has been solid over the past year, and the radio service has made its presence felt in cars, as well as mobile devices. It currently only has around 25% market share of all the cars on the road, but with new car sales of 16 million estimated this year, there are plenty of opportunities.

Major deals of late boost growth

Over the past year, Sirius inked deals with Toyota (NYSE:TM) and Honda (NYSE:HMC), and extended its deal with Nissan (OTCPK:NSANY), while also forecasting that 11 million cars this year will be fitted with satellite radio (compared to 10.7 million cars last year). Also, 60 million cars are currently fitted with factory-installed radio satellite services, and this figure is expected to climb to 100 million cars over the next five years.

It is also making a serious move in the used car market, and expects sales in this segment to exceed the new car market. In an effort to acquire customers, free trials are offered through 2,500 dealers in its network, and in 2013, 13 million free trials were offered at a conversion rate of 34%, taking into account both new and used cars. The company currently has a market share of about 70% for new cars in the United States.

Business model diversification

At the end of 2013, Sirius completed its acquisition of the connected vehicles services unit of Agero, and the unit will be renamed Sirius XM Connected Vehicle Services. This acquisition will place Sirius in a strong position to offer unparalleled telematics services, along with relationships with a number of leading automotive manufacturers, including Toyota, BMW and Honda.

The connected vehicles services will provide several services, such as vehicle maintenance information and location-based traffic information, as well as help with navigation and voice texting. The deal has the potential to double Sirius' current U.S. market share of 25%, helping distance itself completely from music streaming service providers.

Fundamentals are strong and support growth

The fundamentals are strong. In 2013, it posted a 12% Y/Y increase in revenues to $3.8 billion. Operating income was a record $1.04 billion, with an operating margin of more than 27%. Net income was $377 million, translating into an EPS of $0.06 per share.

Free cash flow generation grew by 31% during 2013 to $927 million. Share buybacks amounted to $1.76 billion during the year, and the company has authorization for a further amount of $2.2 billion that's still to be executed.

Sirius also added 1.66 million subscribers during the year, ending 2013 with a total of 25.6 million. Self-pay subscribers grew to 21.8 million, compared to 20.6 million in the preceding quarter, putting the conversion rate for new vehicles at 42%.

The churn rate was only 1.8%, with the most encouraging fact being the growth in average revenues per user, which grew from $12.12 to $12.46.

What's the outlook really look like?

The key for Sirius is the broadening of its target customer base. The used car market is roughly three times the size of the new car market, and Sirius is making serious moves to penetrate this market. It is trying to reach out to used car owners by using their dealer network when they service vehicles. It already offers a commercial free experience with highly differentiated content and more into connected vehicles services.

The Liberty Media conundrum

In January, John Malone, the chairman of Liberty, made a bid of $3.68 a share to buy the 48% of Sirius that he does not already own. The offer has been called ludicrous by consumer activist Ralph Nader, and there have been calls for the offer to be increased. Sirius has appointed consultants to assess the offer and assist the board in negotiations, but the future outcome is still in doubt. And the latest news includes the fact that Liberty pulled its offer. However, the news isn't all bad - Sirius will now resume its stock repurchase program.

Bottom line

Sirius still appears to be a solid investment. Sirius is looking to diversify its business model from a pure radio entertainment provider to also a web-based safety and navigation information provider for cars. The stock still trades at a discount to the previous Liberty offer price, but fair value is still north of $4. The free cash flow margins on the business are more than impressive. Assuming Sirius can grow free cash flow at a 6% rate over the next five years, then 4% over the long term, coupled with a 10% discount rate suggests a fair value of $4.10.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.