By Rob Carroll
Sirius XM Radio (SIRI) added 329,000 net subscribers in the fourth-quarter of 2010, to reach a total of 20.1 million paying customers. The firm saw revenue growth of 12% in the same quarter. In December, the company’s golden goose, Howard Stern, signed a new five-year deal worth an estimated $400 million to stay with the satellite radio provider amid speculation that he’d leave to sign a $600 million deal with Apple’s (AAPL) iTunes, even taking the pay cut he swore he’d never take (his 2006 deal was for 5 years/$500 million). This suggests some analysts were correct when they claimed that the 2008 merger between Sirius and XM Radio would increase leverage for the partners when dealing with on-air talent, and drive contract prices down now that the two firms were no longer bidding against one another. Near-term growth for Sirius is likely. Average revenue per customer increased. And yet, as we sidestep this giant snowball of optimism, we can’t help but remain skeptical, content to watch from afar as it continues to trend downhill. In our opinion, Sirius XM Radio still faces a very uncertain long-term future, and it wouldn’t surprise us a bit if just down past that ridge, a tree line awaits.
Metaphors aren’t for everyone, so we’ll start with this: Sirius XM is in considerable debt. As of June 2010, the firm had $259 million in cash and about $3 billion in outstanding debt. This may not concern some, but it is worth noting, especially considering that Sirius has never generated positive net income. Bulls will point to the growing subscription base as a sign that future earnings will continue to grow as well, but the real question remains: Will subscriptions grow enough to make the company money?
Automakers will have a large say in determining the answer to that question. By agreeing to install Sirius XM radios in their new models, car manufacturers provide Sirius with a significant source of new subscribers (roughly two thirds of SIRI’s subscriber base originates from the automotive channel), and since a majority of radio listening is now done while driving, these particular subscribers could be vital to the company’s growth. Unfortunately for Sirius, its automotive partners now require incentives to install the firm’s satellite radios since installation is not crucial to their models. The belief is that many car buyers are content with terrestrial radio and its free AM/FM offerings, and for the automakers, cheaper, proprietary alternatives to satellite radio continue to emerge. For example, Ford’s (F) MyTouch with SYNC already allows users to connect wirelessly with their smartphones and play recorded content through the car’s audio system, and Ford is now working with Pandora Internet radio to make its streaming content available through Pandora’s smartphone application. Many makes and models also offer iPod connectivity, a widely used, almost iconic device, which now offers much more than just music.
Sirius XM also faces considerable competition outside the automotive market as wireless access becomes more available--almost to the point of being everywhere--essentially transforming free streaming radio options from Apple, Pandora, and the rest of the Web into Internet equivalents of satellite radio. With a laptop or mobile device and an Internet connection, listeners can get radio services similar to what Sirius XM provides as part of their existing cable plan, or if in a complimentary hotspot, for free. Now, it is not safe to assume that people without Internet service or mobile devices capable of streaming digital media will choose to spend on this option instead of going with satellite radio, nor is it fair to assume that those with Internet and mobile streaming options will choose not to also subscribe to Sirius XM radio. However, it is safe to speculate on the difficulty of growing a subscriber base while deep in debt when cheaper, redundant alternatives exist and are already widely in use, and we believe that the difficulty will be great. And that doesn’t even take into account the possible subscription cancellations Sirius XM may have to deal with if customers decide to turn to these newer emerging options.
Some will argue that Sirius is just a superior product to the aforementioned alternatives with superior programming, but the rebuttal to that claim remains the same. The argument is not whether Sirius XM provides a good service or if it will continue to grow, but whether or not it can continue to grow at a rate sufficient to fuel profits and sustain that rate to satisfy investors in the long-term. We don’t think it can.
Shares of SIRI currently trade around $1.80. Our fair value estimate is $0.60 apiece.