Is it really a good time to buy Sirius XM Holdings (NASDAQ:SIRI)? The company has been having difficulty increasing the Average Revenue Per User ("ARPU"). The growth in self-pay subscribers is slowing. Majority owner Liberty Media (NASDAQ:LMCA) has proposed three different strategies that could affect the share price of Sirius since the beginning of the year. And, the share price is down nearly 20% from the $4.18 multi-year high reached last October.
Well, Zack's seems to think it's a buy, "based on the company's back-to-back deals with automobile manufacturers, Ford Motor Co. (NYSE:F) and Chrysler Group." I think the impact of the recent Ford and Chrysler deals won't be all that much help to the top line, and smartphones and cheap GPS devices are more than adequate as substitutes.
Despite all this, the company is still generating a reasonable amount of free cash flow ("FCF"). Sirius is projecting approximately $1.1 billion of FCF this year and over $4 billion of revenue. Before getting too excited about the FCF generation of more than a quarter for every dollar of revenue, one must remember that there are currently more than 6 billion fully diluted shares. So, how much FCF per share should we expect?
The company indicated that there were about 5.94 billion shares outstanding at the time the first quarter 10Q was issued. It is also known that the company will almost certainly be issuing 272.9 million shares in Q4 when its 7% Exchangeable Notes mature. With the company having approximately $1.7 billion left on its authorizations for buybacks remaining, and with the company continuing to buy back shares, it's possible it could purchase as many as 500 million shares (at $3.50 per share) by year end. That would bring the share count down towards 5.7 billion shares. With $1.1 billion of FCF, the FCF per share would come in at about nineteen cents per share.
It's also reasonable to expect the FCF for 2015 to increase and a new share buyback to be authorized, funded in part by increased borrowing. As the FCF per share drives towards 23-25 cents per share, the multiple on the FCF is likely to contract due to:
- Slowing growth, and
- Rising interest rates.
As interest rates begin to rise - and many now believe that rates will begin to rise as early as the first quarter of 2015, investors will begin to demand more from stock investments and the cost of borrowing for Sirius will begin to ratchet higher.
Despite all of these considerations, I am suggesting that it is time to open a new position on Sirius. It may seem strange, but because I have much lower expectations than most, and because the use of covered calls can set up a reasonable expectation of a double digit yield, there are attractive opportunities. Those returns can approach a 20% yield. Here's how it would work.
As I write this, shares of Sirius are trading at $3.38 bid and $3.39 asked. At the same time, one can sell January 2015 $3.50 covered calls for $0.19 bid (the asked is $0.22, so there is a good chance that one can get an order executed somewhere between the end points of the spread). Ignoring commissions, one's net cost would be $3.20. I would fully expect that the shares would be assigned by the January 17th expiration on the assumption that the stock would be trading above $3.50. So,
$3.50 / $3.20 = 9.4%
cash return, and a compounded yield of 19.6%. Using the same strategy, but extending it out to the January 2016 $3.50 calls ($0.43 bid / $0.53 asked) should generate a cash on cash return of at least 18%, although since the time horizon is much longer, the yield would be in the low double digits. Also, since the spread is much larger, one could do better than the 18% cash on cash return.
Are there risks? Absolutely. As with any investment there are always risks. The stock might not reach $3.50 and it could even fall below $3.20, in which case you would be left with the shares. Or, the stock could trade well above $3.50, and you would have lost out on the possibility of significant upside. The analysts think the latter case is far more likely, especially if one were to go out towards 2016. Yahoo!Finance has the mean target at $4.28 and the median at $4.33, with a low of $3.50 and a high of $5.
These price targets would suggest a more aggressive approach would be to simply buy the stock and forget about the calls, or at least use the $4 call option for 2016 which can be sold for $0.25. Assuming the analysts are correct, one's adjusted cost basis $3.14, and if the shares were to be assigned at $4, the cash on cash return would be 27% and the annualized yield would be in the high teens. (Note that the January 2015 $4 call is trading at only $0.07 bid and is hardly worthwhile.)
Covered calls are one of the least risky option strategies and they are approved for IRAs. While not for everyone, they do provide an opportunity for an attractive yield while selling a portion of the risk to someone else.
Disclosure: The author is long SIRI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. In addition to my long positions, I have January 2015 $4 covered calls written against portions of my long positions in Sirius XM. I also trade blocks of Sirius XM on a regular basis. I have no positions in any of the other stocks mentioned in this article.