A Look At Sirius XM's Falling ARPU

May.14.14 | About: Sirius XM (SIRI)

Summary

ARPU has shown a sequential decline.

Retention and acquisition discounting appears to be rising.

Price increases insufficient to counter increasing discounts.

Average revenue per user, or ARPU, is one of the key operating metrics that Sirius XM Holdings (NASDAQ:SIRI) reports each quarter. Sirius defines ARPU in the current 10Q as follows:

ARPU is derived from total earned subscriber revenue, excluding revenue derived from our connected vehicle services business, net advertising revenue and other subscription-related revenue, net of purchase price accounting adjustments, divided by the number of months in the period, divided by the daily weighted average number of subscribers for the period.

How useful is ARPU? The company states ARPU is a

key metric we use to analyze our business. Over the past several years, we have focused substantial attention and efforts on balancing ARPU and subscriber additions. Our ability to increase or maintain ARPU over time is uncertain and depends upon various factors, including:

  • the value consumers perceive in our service;
  • our ability to add and retain compelling programming;
  • the increasing competition we experience from terrestrial and Internet radio and other audio entertainment and information providers;
  • our ability to increase prices; and
  • discounted offers we may make to attract new subscribers and retain existing subscribers.

Our profitability could be adversely affected if we are unable to consistently attract new subscribers and retain our current subscribers at prices and margins consistent with our past performance.

ARPU is quite useful insofar as it gives an indication of how much the "average" subscriber pays for the service each month, although there are a number of factors that can distort the figure. This article will examine the ARPU for the most recent quarter, which came in at $12.18, down $0.28, or more than 2.2%, from the $12.46 posted in the previous quarter. At first glance, it is a large drop, especially considering the fact that a price hike went into effect at the start of the year.

It would seem to be a simple task to track and understand this figure. After all, for years the company has essentially sold one product - subscriptions to satellite radio service. There are many factors that make analysis of this figure complex:

  • A change in the definition of ARPU appears to have eliminated some of the revenue included during the previous quarter, exaggerating the extent of the decline.
  • There are two components to basic pricing; the monthly subscription rate and the Music Recovery Fee or MRF.
  • The MRF has changed numerous times over the years. Initially, it was set high (with approval by the FCC) during the post-merger price freeze in order to recover past royalty payments incurred for the right to broadcast music. It was subsequently reduced, and then changed to reflect annual changes in the royalty fees. It is also changed as subscription fees rise and fall.
  • Management has stated that price changes take an average of 18 months to flow through the subscriber base.
  • There was a shift by a major OEM to unpaid trials from paid promotional trials in Q4. The company aggregates self-pay and paid promotional subscribers together, and has not disclosed the amount of the paid promotional subscriber rates, although that rate has been widely believed to be lower than the standard rates.
  • The company offers many pricing plans, including multi-year discounts, Family Plan discounts, a la carte pricing, bundled offerings and combinations of bundled offerings with multi-year discounts.
  • The company recently introduced a deeply discounted plan targeted at the Hispanic market.
  • In addition to the other discounts, the company has many subscribers receiving acquisition or retention discounts. At one time these discounts were reported to apply to about 14% of self-pay subscribers.

The first bullet references a change in the definition of ARPU. The phrase in bold in the most recent definition (above) is a change from the previous definition in the 10K (shown below).

ARPU is derived from total earned subscriber revenue, net advertising revenue and other subscription-related revenue, net of purchase price accounting adjustments, divided by the number of months in the period, divided by the daily weighted average number of subscribers for the period.

The connected vehicle services division was acquired in early November, and although it generated revenue in 2013, the amount is not known. How do we know it generated revenue in Q4? From the following statement in the 10K:

Subscriber Revenue includes subscription, activation and other fees.

• 2013 vs. 2012 : 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.

From the 10Q we can derive the connected vehicle subscription revenue for the first quarter of 2014. It states that "Subscriber revenue, excluding connected vehicle (GAAP)" is $832,804,000 and that the "Subscriber revenue" is $851,436,000. Therefore, the connected vehicle services ["CVS"] revenue was $18,632,000 during Q1 2014. Next, we can estimate the amount of revenue from CVS included in Q4 of 2013 in order to gain a better understanding about the change in ARPU.

On numerous occasions management has stated that CVS should generate $100 million in revenue in 2014, that it is growing at double digit rates and that it is expected to double in three years. We also know that the acquisition closed on November 4, 2013. We can conclude that CVS generated 1.9 months of revenue in Q4 of 2013 compared to three months in Q1 2014. That would put the CVS component of subscriber revenue in Q4 at a rate of less than $6.2 million/month or less than $12 million for the quarter. Considering the rate of growth expected by Sirius, it is possible that CVS subscription revenue may have even been $10 million or less. Using $12 million of CVS subscriber revenue and the daily weighted average number of subscribers of 25,267,241 in the quarter, CVS would have contributed $0.158 per month to ARPU in Q4 and using $10 million, it would have contributed $0.132.

While the CVS inclusion in Q4 distorted the growth in ARPU to $12.46 in Q4 from the $12.29 in Q3, it also distorted the extent of the decline from $12.46 all the way down to $12.18 in Q1. However, even if we adjust the Q4 ARPU down to $12.30 ($12.46-$0.158 CVS component) there was still a noticable decline of $0.12 to $12.18. This decline took place in an environment where the underlying trend should have been to see increasing ARPU.

Factors that should have been contributing to the growth in ARPU were a price increase that began phasing in on January 1, 2014, the shift of one major OEM to unpaid trials and an increase in "Other subscription revenue" comprised mostly of the MRF. Other subscription revenue increased $1,657,000 from $79,111,000 in Q4 to $80,768,000 in Q1. The contribution to ARPU would equate to just over plus 2 cents per month.

Unfortunately, this was more than wiped out by the decline in advertising revenue, which fell by $3,188,000 from $25,402,000 in Q4 to $22,214,000 in Q1. That change in advertising revenue contributed $0.04 to the Q4 decline in ARPU. I would expect advertising revenue to show a sequential decline from Q4 to Q1 as holiday related ad spending spikes in Q4, so that component is not much of a concern, and there was solid year over year growth in ad revenue.

So, if the changes in advertising, other subscription and CVS revenue accounted for a net decline of 16 cents, and the overall decline was 28 cents, what caused the decline of the additional 12 cents per month? And, again, this occurred in an environment where there was a price increase phasing in.

Focusing on the Decline

It is clear that ARPU has declined. It is a figure that has risen steadily since the merger (with the exception of a 2011 decline tied to the MRF catch-up adjustment). As noted earlier, there should have been factors at work that drove this metric higher.

Clearly, a January 1st price increase should have begun contributing to the increase in ARPU in Q1. The increase was from $14.49 to $14.99 per month for the basic monthly subscription plan. While the price increase was relatively small and did not affect all subscribers or pricing plans, it should have had some positive impact.

A positive impact would also have been expected from the OEM shift. The shift away from paid promotional subscribers would have reduced the number of subscribers, but these would have been subscribers where Sirius is believed to be generating discounted monthly subscription rates. Their removal should have resulted in an increase to the average.

Clearly, these two factors were not enough to drive ARPU higher, even on an adjusted basis. There are several possible explanations, and clues can be found in the 10Q:

For the three months ended March 31, 2014 and 2013 , ARPU was $12.18 and $12.05 , respectively. The increase was driven primarily by the contribution of the U.S. Music Royalty Fee, and the impact of the increase in certain of our subscription rates beginning in January 2014. The positive result was partially offset by growth in subscription discounts offered through customer acquisition and retention programs, lifetime subscription plans that have reached full revenue recognition and a change in a contract with an automaker.

The sentence in bold discusses the changes relative to Q1 of 2013 and mentions the impact of lifetime subscription plans, the OEM shift and retention/acquisition discounts. There is no reasonable way to ascertain the impact of lifetime subscriptions reaching the end of revenue recognition on revenue or how much it contributed to the change in ARPU. (It should be noted that while it impacts revenue, the lifetime sub issue has no impact on cash flow.)

The OEM shift seems counter-intuitive, and an explanation has been requested from the company. If the "change in a contract with an automaker" had a negative impact on ARPU, it implies that those paid promotional subscribers were generating more revenue than the overall average of more than $12 for all subscribers. This is contrary to the widely held belief that the OEMs paid less than self-pay subscribers. (As of the time this article was submitted for publication, there had been no response from Sirius to the clarification request.)

The final item is the "growth in subscription discounts offered through customer acquisition and retention programs". It has long been known that Sirius offered retention discounts, although the inclusion of the adjective growth is a change from prior reports. This suggests that the company has stepped up programs to acquire and retain subscribers, and is offering more discounts to achieve subscriber growth. One of the "discounted" acquisition programs that has been introduced recently and could have begun to impact ARPU in Q1 was the Hispanic subscription offer. This package is priced at just $5.99 per month.

Summary

ARPU is an important metric. As the company noted:

Over the past several years, we have focused substantial attention and efforts on balancing ARPU and subscriber additions.

Sirius has long offered discounts to maintain and grow its subscriber base. The recent declines in both total revenue and ARPU suggest that the company, despite price increases, is finding it increasingly difficult to grow the average revenue it generates from each subscriber while trying to grow the subscriber base.

ARPU, subscriber growth and revenue growth are key metrics for investors to track. Whether Q1 was an aberration, or a signal of sharply declining growth remains to be seen, and how well the company succeeds in "balancing ARPU and subscriber additions" is certainly something that investors should carefully follow.

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: I have June 2014 and January 2015 $4 covered calls written against several of the SIRI positions. I also actively trade SIRI. I may initiate new covered call positions or close out or open new positions in SIRI at any time.