I just love reading articles and watching interviews of supposed media analysts claiming Sirius XM Radio (SIRI) is overvalued. Each time they do, it creates opportunities for me to add to my position.
Over and over, I have witnessed these experts proclaim the overvaluation of Sirius XM, based solely on currently known, and usually outdated, fundamental data. These experts ignore a fundamental law of investing that says the market does not make mistakes. In the case of Sirius XM Radio, the market is not making a mistake. Rather, the analysts that make the overvalued argument are admitting that they do not understand the underlying story, and therefore are out of their league, effectively mocking themselves.
I've previously highlighted several mistakes that these analysts make, which all stem from their EV/EBITDA calculations. The enterprise value is a company's debt, plus the value of its outstanding stock, minus its cash on hand, which is then divided by Earnings Before Interest, Taxes, Depreciation and Amortization. They look only at the last known numbers reported, and then make future assumptions that will affect this equation. It is in these assumptions that they fall short, simply because they cannot think for themselves by factoring in the unknown.
This has been an ongoing story with Sirius XM for two years, as management has consistently reported better numbers than the assumptions that were made by the pundits. As Sirius XM reduces its debt and builds its cash position, its enterprise value falls, forcing the stock price to climb in order to maintain the same enterprise value. EBITDA has consistently proved better than anticipated, which also forces the stock price to rise in order to maintain the same EV/EBITDA multiple.
The most important thing for investors to look at, then, is what the likelihood is that Sirius XM will continue to reduce its debt, build its cash position, and increase EBITDA. If Sirius XM can do any one of these things, the share price should continue to rise. Conversely, if it fails on any of these measures, the share price should fall. For those with forward-thinking capabilities, Sirius XM should improve on all of these valuation essentials, and as Morgan Stanley (MS) noted in its research report, add another in the form of returned capital to shareholders via future share buybacks, which also by nature raises the remaining equity value on an EV/EBITDA basis.
Sirius XM has one remaining satellite launch this year, which was pre-expensed long ago. The company is now free cash flow positive and generating positive earnings, which means the company, barring any intended strategical acquisition plans, has no reason to incur any further indebtedness. Sirius XM has $230 million in 3 1/4% convertible notes due in October of this year, and sufficient cash reserves to retire the note. There is also the hot topic issue of whether or not holders of the XM 7% convertibles with a $1.875 conversion rate might convert as well, which could result in the retirement of up to $550 million in long-term debt. These two notes alone represent roughly 1/4 -1/3 of all the outstanding debt of Sirius XM.
Beyond that, Sirius XM will face no further debt issues until 2013, and it is expected that the company will be generating sufficient cash flow to meet those obligations, based on the currently known fundamentals alone. Unanticipated increases in earnings will only help to bolster investor confidence.
Under-promise and over-deliver. That has been the key accelerator to Sirius XM's market-leading share price appreciation over the past two years. While "bloggers" seem to have no problem anticipating upside surprises, Wall Street pundits consistently under-estimate the company. Retail investors that are kept up to speed on the latest developments from sites such as this one have profited, while the institutions that rely on expert analyst reports have been largely left out, due to pessimism and emotionalism. Despite Sirius XM CEO Mel Karmazin having a 20-plus year history of growing EBITDA at a 20% minimum, analysts continue to forecast lower growth rates, which wrongly raises the perceived EV/EBITDA multiple. I can say "wrongly," because it is now historical fact.
We need to ask ourselves again: "What is the likelihood that Sirius XM will be able to increase its earnings?" There are so many catalysts for earnings growth that are being overlooked, it's inconceivable that anyone could suggest Sirius XM is overvalued: The continued recovery in auto sales; used car marketing; the addition of the "best of" packages with new car trials; potential price increases or package upgrades later this year; the continued synergies resulting from the merger, such as we are witnessing now with customer service being streamlined; advertising recovery and its potential as the economy improves; and perhaps the granddaddy of them all, unannounced revenue sharing agreements with Apple (AAPL) and Amazon (AMZN), resulting from impulse purchasing capabilities now being included in future Sirius XM offerings.
Consider the following timeline of some of the biggest sales milestones for iTunes:
- April 2003: iTunes launches
- July 2005: 500 million
- February 2006: 1 billion
- July 2007: 3 billion
- June 2008: 5 billion
- February 2010: 10 billion
Amazon also continues to grow its digital music sales as well. The new Sirius XM online player now makes it possible to purchase songs while listening to live radio. Patents we have reported on make it clear that this feature will be available in all future Sirius XM offerings. Most radio listening occurs in the car, and the ability to purchase an individual song, show or live performance is an enormous and over-looked aspect of those purporting Sirius XM to be over-valued.
Liberty Capital's (LCAPA) stake in Live Nation (LYV) may provide for ticket sales to occur in the same way in the not-too-distant future. I would not be surprised to learn of a partnership between Sirius XM and Live Nation to be announced within the next 12 months.
All of the above will result in increased EBITDA as time goes on, which suggests that the EBITDA estimates used to calculate EV/EBITDA are being highly under-estimated. Increases to EBITDA justify increases to Sirius XM's equity share price again, simply to maintain the current "market dictated" multiple.
Based on the current forecasted models, several bullish analysts have suggested that Sirius XM will soon be generating from $1-1.5 billion in free cash flow in the coming years. Cash is king, because in Sirius XM's case, it will determine its ability to become net debt positive. Remember the EV calculation above. Cash reduces the enterprise value and, therefore, lowers the EV multiple. If Sirius XM can accumulate $3 billion in cash by 2013, it will become net debt positive.
As the above begins to occur, Sirius XM will continue to climb slowly, and methodically. The question I must ask myself then (if I in fact believe my own research) is whether I want to own Sirius XM below $2.00 / share, or wait until these events have already occurred such as the pundits do today, and pay two to three times more later, at the least. And that is without having factored in the potential for the share buyback program that the company has suggested and which Morgan Stanley highlighted.
Read any analyst's report, and the one common denominator in support of risk is the potential for Internet Radio to take market share from Sirius XM. I have written dozens of articles on why this threat is empty, and see no need to rehash them here. I believe it to be nothing more than smoke and mirrors, designed to scare retail investors out of their shares at these rock bottom prices, while institutions continue to accumulate and build positions.