By Brandon Matthews
Sirius XM (NASDAQ:SIRI) is scheduled to report earnings this Thursday, November 4, 2010.
Conference calls focus on events that have already transpired. I have always found it interesting that events that occurred 6 -18 weeks ago can have significant effects on a stock "in the moment," when in fact markets are said to be forward looking. While my forte and area of expertise centers primarily on technical analysis and research into future possibilities, Mr. Costa brings to the table a greater understanding of fundamental analysis. Still, that won't stop me from throwing my two cents into the discussion...which brings me to my latest revelation that could cost Sirius XM investors a lot of money.
We've already heard from several analysts, not to mention the bash crew over at CNBC regarding Sirius XM's EV/EBITDA valuation. Even some analysts are being swayed into this overvalued mentality. With Sirius XM now trading near $1.50, I fear others may give into this "stinking thinking." I recently wrote two articles using Netflix (NASDAQ:NFLX) as a comparison, to demonstrate that the high EV/EBITDA multiple argument is pointless.
My research last week led me down a path, however, that makes not only a comparison a moot point, but clearly demonstrates that the analysts themselves are not considering the big picture. Analysts can only work with what they know. What they do not know, is how to project events that might transpire before they occur. Let's look at the numbers that CNBC and negatively biased analysts want you to focus on so closely, shall we? Trust me...you're going to like this.
There is a fundamental flaw in the calculations being used to arrive at a 2011 EV/EBITDA multiple. I'm assuming that like me, most of you reading this do not have degrees in accounting; "EV" means enterprise value and "EBITDA" means Earnings Before Interest, Taxes, Depreciation & Amortization. Enterprise Value is the equity (stock value), plus debt, minus cash. Don't worry...there will be no test on this. The analysts and media are focusing on this one pointless metric, to make a case that Sirius XM is trading higher than 17X next year's EV/EBITDA. That is where they are wrong. I know this is boring, but trust me. It's worth it.
Currently, Sirius XM's EV/EBITDA value breaks down as follows (FULLY DILUTED):
2010 year end estimate (Q2 results and company guidance used)
= EV of 12,315,308,500.00
/ (ebitda) 575,000,000 =
21.4 is the current year's multiple. Got it? Good.
When the analysts calculate next year's EV/EBITDA, the only basic change they make is to the EBITDA number, and ignore the others. Their estimates for 2011, looks similar to this:
(Equity)9,545,932,500 + (Debt)3,028,230,000 =12,574,162,000 -(cash)258,854,000 = EV of 12,315,308,500.00 /690,000,000 =
This 17.8 multiple had media analysts on CNBC suggesting that Sirius XM shares were overvalued, when the multiple was only 17 a few weeks ago. At 17.8 they will no doubt be throwing their hands in the air wondering where they went wrong. Allow me to explain exactly where they went wrong. (This is the good part.)
Last week, I wrote about some convertible debt that is likely to come into play in the very near future. You probably just glanced over it, but there was an SEC filing issued by Sirius XM on August 19, 2010. It was a prospectus supplement that gives some of the holders of those notes, the right to convert and sell their converted shares. There have been many such supplements issued, but the timing of this one suggests that the institutional holders of these notes are lining up to convert the bonds.
As I previously mentioned, that can occur once SIRI shares hit $1.875. While some I'm sure would point out that the holders of the notes are under no obligation to do so, I believe they will and the SEC filings seems to substantiate that belief.
In converting, not only will $550,000,000.00 of Sirius XM debt be washed away, these are the same notes that Sirius XM issued 262 million shares of common stock against. There remain 202 million of these loaned shares to be returned and retired, when the holders of these notes convert. That means that not only will debt decrease in 2011, but equity as well, which in turn lowers the 2011 EV/EBITDA multiple that is being so negatively focused on. Moreover, Sirius XM's cash position at the end of 2011 is expected to reach approximately $1 billion. When we plug in these numbers, we see a shift in next year's EV/EBITDA multiple:
- Equity is reduced as the loaned shares are returned from $9,545,932,500 to $9,242,332,555.
- Debt is reduced from $3,028,230,000 to $2,478,230,000.
- Cash is increased from $258,854,000 to $1,000,000,000.
(Equity)$9,242,332,555+ (Debt)$2,478,230,000=$11, 720,562,555 -(cash) $1,000,000,000 = EV of $10,720,562,555/690,000,000 =
15.5X 2011 EBITDA
Compare THAT to Netflix. Did I mention, that in 2009, Sirius XM traded at over 25X EV/EBITDA? This all suggests that Sirius XM has a lot more upside potential than some would have you believe. I don't believe for a moment that I'm smarter than any of the professional analysts out there. No, this is information usually discussed at the country club. This is the kind of information usually withheld for clients and high net worth prospects. In the coming days, I have no doubt that the topic of Sirius XM being overvalued will be plastered all over creation, using various forms of media - a tactic employed and designed to separate retail investors from their shares, so the "smart money" can take them off your hands.
Want more proof? Consider that back on February of this year, the exact same argument was being used before Sirius XM ever generated a single dollar in EBITDA and an auto recovery was questionable. For the better part of this year, the smart money has loaded up on the "overvalued" equity. See how it works? Time and pressure. "They" have infinite time, and the ability to apply pressure. Which is exactly what they did throughout 2010 on the supposedly overvalued Sirius XM common stock. Institutional ownership went up at the expense of the retail shareholder, which made a "Siriusly" big mistake in buying into the overvaluation argument.
As long as Sirius XM continues to increase revenue, cut costs and reduce debt beyond that of analyst expectations, the "overvalued" argument will remain the wrong argument.
Disclosure: Long SIRI