4Q Shows Model Works but Shares Still Pricey

| About: Sirius XM (SIRI)

Sirius XM (NASDAQ:SIRI) reported a mixed 4Q10 earnings result and provided 2011 guidance that missed on all metrics, except subscriber net additions. 4Q10 net subscriber additions of 329K was slightly below the consensus of 330K. Self-pay churn of 1.9% was in-line with consensus, ARPU of $11.80 was below consensus of $11.95, and SAC per gross add of $58 was better than consensus of $61. EBITDA of $144 million was ahead of consensus of $142 million.

2011 revenue guidance of $3.08 billion was below consensus of $3.1 billion, and EBITDA of $715 million was below consensus of $768 million, but subscriber net additions of 1.4 million was meaningfully ahead of the consensus of 1.3 million. Guidance outside of the net adds was unimpressive, but SIRI has a history, we believe, of downplaying expectations.

The drop in OEM conversion to 45% was concerning but SIRI attributed that to OEM mix rather than a structural issue. We are comfortable with that.

On the call, management stated that it sees an operating margin of 40% at maturity, continual programming cost declines both on an absolute basis and as a percent of revenues, self-pay churn in 2011 similar to that in 2010, and declining capex until about 2016-17. In addition, management hinted at future price increases and thought that a share repurchase is a more efficient means of returning cash to shareholders in the future. Most on the Street believe that the share repurchase may take place in the second half of 2012 after the quirks of the Liberty Media transaction have lapsed. These are all great, but are already backed into Street models.

One positive, we think, is that the net addition guidance of 2011 was based on a 12.5 SAAR for 2011; most estimates have a SAAR number for 2011 far north of that figure ... so there could be some upside there.

A few shops raised price targets to $2 for 2011, implying a multiple of 18x. Some are now comparing SIRI to tower companies who trade at 17-18x EV/EBITDA and have high leverage. However, that is a faulty comparison because tower revenue streams and cash flow are highly predictable, with near zero churn, whereas SIRI depends on metrics such as OEM conversion, churn, SAC per gross add, etc. that are more variable and have to move in unison in the right direction for this model to work. One deviation in any one metric, likely competition-driven, could change that profile.

The takeaway from the results is that the model works as long as SIRI is able to get subscribers from the OEM channel, i.e., conversion, stays in the mid-40% range, churn holds at current levels, and expenses are managed down. Currently 60% of all new cars leave the assembly line with a satellite radio installed and used cars serve as a long-term opportunity for SIRI -- but not in the near-term, we believe. With the 30 million cars on the road with a satellite radio at the end of 2010, minus the 18 million or so self-pay subs, what's left is 12 million or so inactive subscribers, which cost less to market to than a sub coming thru the OEM method.

However, we continue to believe that the shares are pricey and were looking for a more meaningful pullback post earnings than the 8% that we saw, which was then followed by the 7% recovery the day after. A 20% pullback would have gotten us interested in buying. That day may yet come.

We took a look at Street models, and all have SIRI growing EBITDA 14-15% over the next few years. We see no argument that would warrant a multiple in excess of the growth rate, and at a 15x multiple the shares should trade 20% below the current implied price targets by the sell-side analysts. For instance, based on 2011 consensus EBITDA, applying a 15x multiple should imply a share price of $1.60 today, 12% below the current share price. So based on this intrinsic valuation, we won't necessarily get the $1.40 share price we were looking for in our first write-up, but this continues to suggest that the shares are overvalued.

Pandora is a long-term competitive threat. If cell phone carriers can get their services into the dashboards of automobiles seamlessly, and Pandora builds up enough cash to pay for talk show and sports content, then that scenario could pose a significant challenge to SIRI. At the moment, we do not see that happening near-term, but this could be a long-term risk. Pandora did state in its IPO filing:

Expand Distribution. We are expanding our reach to new mobile, consumer electronics, and automotive platforms.

Expand Content Formats. Although music format stations represent 80% of total radio share according to Arbitron, a media and marketing research firm, many radio listeners are drawn to sports, talk, news and other forms of content beyond music. We think there is an opportunity over the long term to offer these types of content in addition to music.

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