Sirius Upgraded on Future Growth Potential

Includes: LMCA, SIRI
by: Satellite Radio Playground

By Demian Russian

Gabelli & Company analyst Brett Harriss upgraded Sirius XM Radio (NASDAQ:SIRI) today from a HOLD to a BUY rating. Rather than put a 12 month price target on the equity, Harriss sees the stock trading on future growth and points to a 2015 PMV (Private Market Value) of $3.25. Harriss sees Sirius XM having pent-up pricing power and believes that the company could initiate stock buybacks in the second-half of 2012, subsequently returning ~$6 billion in capital or 55% of the company’s ~$10.9 billion market capitalization by 2015.

Since inception in 2000, Satellite Radio has never increased its subscription price despite the addition of new content. Sirius customers are loyal: 1.9% monthly churn is low compared to other subscription businesses and did not spike through the recession. With a relatively modest subscription price, we think SIRI can raise prices without significantly impacting consumers’ budgets.

– Brett Harriss, Gabelli & Company

Harriss notes that while Sirius XM has never increased its base subscription price, except for implementing music royalty recovery fees, the company has "substantially improved its content offerings," noting the additions of Howard Stern, Opie & Anthony, and major league sports programming. He calculates that if Sirius XM were to have raised prices in tandem with inflation of ~2.5% over the last 10 year period, their base subscription would be around $13.50, as opposed to that of ~$10.40 currently — equating to a ~$3.00 premium. In contrast, he points to other subscription based businesses which have historically raised prices at single digit rates annually.

In his case for Sirius XM’s pricing power, Harriss also points to the fact that the company’s churn rate improved year-over-year from 2.1% in 2009 to 1.9% in 2010. "Even at the height of the economic crisis, churn never exceeded 2.2%," Harriss notes. While he sees the competitive landscape changing, with Internet Radio service providers such as Slacker and Pandora providing commercial free music to smartphones, Harriss doesn’t view these competing services offering “the news, talk and sports content required to offer a comprehensive radio product."

While Harriss sees Sirius XM having the freedom to raise prices beginning this August, he doesn’t see the company implementing a large price increase right away. He expects the company to start out slow, gradually increasing subscription renewal rates and reducing discounts. Harriss’ base case assumption calls for a 4% price increase annually from 2012-2015.

Through 2015, Harriss sees Sirius XM’s FCF (Free Cash Flow) benefiting from 6% subscriber growth, 10% revenue growth driven by 4% ARPU (Average Revenue Per User), operating leverage resulting from ~65% incremental EBITDA margins, no cash outlay for taxes because of the company’s ~$8 billion in NOLs, and a substantial reduction in CAPEX (Capital Expenditures) as a result of Sirius XM’s current satellite deployments being completed this year. For full-year 2011, Harriss is projecting that Sirius XM will generate $3.1 billion in revenues and $785 million in EBITDA.

Although Harriss is upgrading his recommendation on Sirius XM Radio from a Hold to a Buy rating, he says that he prefers to own shares through Liberty Capital (LCAPA) rather than buying the SIRI common, as he sees Liberty Capital trading at a 30% discount to its NAV (Net Asset Value).

Disclosure: Long SIRI