With just a few days to go before Sirius XM Radio (NASDAQ: SIRI) reports its first quarter, 2011 results, the company again has investors wondering what that news will bring. The company is scheduled to release its financial and operating results on Tuesday, May 3rd, with a Conference Call scheduled for 8:00 am ET.
Unlike past quarters, where pre-released numbers came with the announcement of the scheduled conference call, or as a result of the company’s participation in an institutional investor conference, this quarter management has remained silent on its performance. No fanfare from the company on subscriber net additions, projected revenue, or anticipated adjusted EBITDA for retail bloggers, or professional analysts to begin to gnaw on. All are left with last quarter’s results, our own assessment of the company’s economic environment, the company’s own timid guidance for 2011, and any tidbits of news that may impact outcomes to figure out what will be reported in the company’s mandated release of quarterly information. Quite simply, the company is not saying a word and I for one, am not saying that this is a bad thing.
Why Management’s Silence Is Golden
It is widely believed that all companies, not just Sirius XM, prefer not to put forth performance numbers early, but that most find themselves compelled to release them. After all, Sirius XM is more than just a premier content provider, it has also been a great investment vehicle for institutions looking for above market returns on corporate debt investments, and Sirius XM has been active in restructuring and selling its corporate debt. While it has had difficulty seeking financing over the last few years, as did almost every publicly traded company, they also provided decent returns on corporate debt to those who stepped up to the plate. John Malone’s Liberty Media Corporation (NASDAQ: LCAPA) is certainly at the top of that list of satisfied investors.
The point is, when a company is in the vulnerable position of selling company debt, which represents a serious promise to pay investors in the future, the company must provide as much proprietary information as is necessary to create a comfort level with investors. It must also provide that information to a fairly large audience of diverse investor types. When company management is out selling the viability of their business, companies put themselves in a position where significant amounts of material information is presented, and per SEC regulation, must now be provided to all who would invest in the company’s debt offerings, including their common stock.
With that in mind, and with all of the restructuring of corporate debt the company has completed, and restrictive covenants that have been removed, management no longer needs to “sell corporate debt” to generate revenue. They are no longer forced to release information that assures future viability to that diverse group of institutional investors, and as a result, to the common shareholder either. In essence, management is now free to run their business in silence, except for mandated filings on insider activities, restructuring events, and other SEC required filing notifications, including quarterly (10Q), and annual reports (10K). They are now free to operate discreetly, with renewed focus on running the primary business, while answering only to their Board, Shareholders, and Customers –NOT the Bondholders.
So this is why the company’s “silence-is-golden” in my view. Sirius XM is a maturing, more stable business that is becoming self reliant on generating revenue from its core operations rather than financing activity. This is evidenced by the company now using cash generated from core operations to maintain its capital expense for property and equipment, fund the innovation of new technology, and pay debt maturities when they become due. This is a “giant leap forward” for the company and its common share investors.
Turning Up The Volume On Q1 Results
Now that we know that we’re not going to get any help from the company in estimating what the actual results were for the first quarter, let's try to extrapolate some important numbers from what we know relating to prior years’ performance, the health of the company’s primary partners in providing its service, and the health of the economy in general.
A good place to start is with what the company said about its own projected performance for 2011. On February 15th, while reporting its full year 2010 and fourth quarter results, the company gave guidance that it expects full-year revenue of ~$3 billion. It projected that the adjusted EBITDA for the full year would approach $715 million. In addition, the company added this;
“With continued improvements in auto sales, and self-pay churn and conversion rates for 2011 similar to our strong performance in 2010, we expect to grow our net new subscribers by another 1.4 million in 2011, continuing our track record of solid subscriber growth. We also expect this year’s free cash flow to approach $300 million.” Mel Karmazin, Chairman & CEO
(EST) -Net Subscriber Additions: Churn 2.0 -2.1%, 296K
Sirius XM’s net subscriber additions are reported in three categories consisting of OEM (original equipment manufacturer), Retail (after market purchase direct), and Rental. A year ago net subscriber additions came in with a positive 171,441. The category of OEM — a positive ~460K subs, Retail — loss of~(305K), and Rental –positive ~16.5K.
It has been the retail subscriber that has been falling off fairly rapidly over the past two years. Many attribute this to the increased amount of vehicles in the used car market that are satellite radio equipped, and also to the lack of new product innovation to attract consumers to the retail outlets. After all, in the early years of satellite radio, if a consumer wanted to listen to the service, purchasing a unit and installing it in their vehicle or home was the only option available. In the last two quarters the net addition drop rate in the retail category has averaged ~(160K), with losses decreasing each quarter as this category begins to stabilize.
The OEM category is by far the key driver of subscriber growth. As was witnessed in 2009, when two OEM manufacturers went into bankruptcy protection, and industry sales on a seasonally adjusted annualized rate (SAAR) fell to ~9 million units, net additions per quarter became net subscriber losses. The OEM channel recovery, combined with effective churn-management, another key metric reflecting management’s commitment to subscriber retention, contributed largely to the resumption of overall subscriber growth. Many observers and analysts feel a churn rate of 2% or lower reflects positively on net subscriber additions assuring future growth.
With the Automotive Manufacturers (OEM) reporting increased sales since 2009, and with this first quarter of 2011 having an estimated SAAR equaling 13.06 M vehicles, it can be anticipated that Sirius XM will do well in future quarters, as “vehicle sales” is generally a “leading indicator” for net subscriber additions. Looking toward the third and fourth quarters of 2010, which came in at ~11.60 M, and ~12.36 M SAAR respectively, with a churn management percentage at 1.9% reported, we should see continued growth Sirius XM’s total subscriber numbers. With a SAAR rate of an additional 1 M vehicles per year, or 250K per quarter, I am adding another 125K subs to last year’s first quarter net additions for a total of 296K.
My estimate would be higher if this quarter wasn’t also going to be impacted by subscribers being counted in this quarter that canceled in the last. Sirius XM generally allows a period of time beyond the cancellation by the consumer for efforts to be made to “reconnect” the subscriber to the service with incentives. With the fourth quarter historically a higher contract expiration period, given the holidays and gift giving, I anticipate churn to be a bit higher also this quarter at 2.0 – 2.1%.
(EST) Total Revenue: $732M – $745M
In the forth quarter of 2010, the company generated $736 million, up 9% on a year-over-year basis from $676 million in 2009. In the first quarter of 2010, the company generated $671 million, up 11% on a year-over-year basis from $606 million in 2009. Given that the company provided guidance for the year based on a vehicle SAAR 12.5 million vehicles, and with first quarter sales running at an estimated 13.05 million SAAR, it is safe to say that an increase year-over-year of 9% is conservative. A more generous increase would be 11%. That gives us a Total Revenue estimate for the first quarter 2011, in the range of $732M – $745M.
While realizing this is a “back of the napkin” generalized approach to reaching this estimate, total revenue should be understood to contain four components: Subscriber Revenue, Advertising Revenue net agency fees, Equipment Revenue, and Other Revenue. For our purposes here, the back of the napkin works just fine. Subscriber Revenue makes up nearly 85% of total revenue generated, with other revenue near 10%, and equipment and advertising revenue the rest.
Other Revenue is the more interesting and controversial of the revenue categories. In the last 5 quarters this category has reflected the largest growth. It includes the U.S. Music Royalty Fee, revenue from affiliates, content licensing fees and syndication fees. It is the U.S. Music Royalty Fee that has generated the most revenue and controversy.
In December 2010, the company reduced the fee it was collecting from music subscriptions from $1.98 to $1.40 to account for actual costs. While this may temper total revenue growth, the net additions of 1.4 million over the last twelve months should be able to accommodate the year over year growth that is projected here.
(EST) Adjusted EBITDA: $175 – $190M
Per the company’s own definition, EBITDA is defined as net income (loss) before interest and investment income (loss); interest expense, net of amounts capitalized; taxes expense and depreciation and amortization.
The company adjusts EBITDA to remove the impact of other income and expense, loss on extinguishment of debt and certain other charges. Adjusted EBITDA is a NON GAAP financial measure and is used by the company to evaluate the company’s businesses, to base internal budgets on, and to compensate management.
Adjusted EBITDA attempts to exclude non operating items from this performance measurement such as, purchase price adjustments from the merger, goodwill impairment, restructuring impairments and related costs, depreciation and amortization, and share based payments. Sirius XM believes that Adjusted EBITDA is an accurate measurement of the underlying trend for operating performance, absent the costs associated with its physical plant, capital structure and purchase price accounting.
The company believes –"Adjusted EBITDA to be the key Non-GAAP financial measure for analyzing operating results of Sirius XM compared to other communications, entertainment, and media companies. They recognize that Adjusted EBITDA is used by investors when making investment decisions to estimate present and future enterprise value.” The company also provides GAAP reconciliation with its filings and both should be used in assessing the full picture of the company’s financial condition.
With the above exclusions noted, let’s look at what Adjusted EBITDA is, as opposed to what it is not, to get a better meaning of the company’s definition. –It is Total Revenue minus Operating Expenses.
Those operating expenses consist of Revenue share and royalties, Programming and Content, Customer Service and Billing, Satellite and Transmission expense, Cost of Equipment, Subscriber Acquisition Costs (SAC), Sales and Marketing, and Engineering, design and development, with General and Administrative finalizing the list.
A year ago, the company used the term Adjusted Income from Operations, instead of Adjusted EBITDA, so year over year there is some confusion in terminology with the definitions being essentially the same. The major difference is that purchase price accounting adjustments had not been defined as they are now, but are excluded from the Non-GAAP Adjusted EBITDA metric just the same. So there isn’t any impact in comparison as reported.
Last year’s Net Income From Operations came in at $157 million for the quarter. My estimate for this year’s Q1 result is $175- $190 million based on increased projected revenue, and good execution of expense management in the quarter. Any significant increase in any one of the operating expense line items would not bode well for the stock price, as many are still waiting to see how the recent contract negotiations will impact the company’s bottom line.
(EST) Net Income: .01 diluted EPS; .02 Basic EPS
With the company reporting both earnings per share on a GAAP basis as diluted and basic, diluted accounting for ~6.5 billion shares outstanding, and basic ~3.9 billion. It takes $65 million in net income to move the stock a penny per share on a diluted basis, and $39 million on a basic earnings per share basis. This leaves this metric as a widely known, but as a poorly reflective measure of the company’s financial or operating performance.
Nonetheless, being positive is profitable and anything else is just not what investors want to see out of Sirius XM Radio at this point. With most of the debt restructuring out of the way for now, it is not hard to see the company beginning to realize improved through-put on net income vs. adjusted EBITDA over the coming quarters.
With a negative ($82) million of earnings in Q4 2010, due to debt extinguishment and restructuring charges, initially reported as a loss of (.02) cents by most media outlets, the real picture lied just below the headline. Without the one-time charges the company reported a positive $64 million, represented as .01 diluted EPS, and .02 basic EPS. It is easy to see how one time charges can quickly erode net earnings without telling of the good debt restructuring that went on during the quarter. Eventually, it is this type of activity that will improve the ratio of adjusted EBITDA to Net Income in the future by elimination of debt, and improvement in the cost paid for interest on what remains.
We know that the company paid $94 million of debt due in October 2011, in February 2011, as was reported in the company’s 10K with discussion of the 3.25% Convertible Notes. So some restructuring charges and cash out will be reported again this quarter. Excluding these charges I am putting forth an estimate of $55 – $65 million in Net income again.
(EST) Free Cash Flow: $25M – $35M
Free Cash as defined by the company is the total Cash provided by Operating Activities, minus additions to property and equipment, minus merger related costs (no longer relevant), and restricted and other investment activity. If we look at the company's past statements of Cash Flows, they consist of Cash Flows from operating activities, which is a reconciliation of all of the cash and non cash activities tabulated, and credited or debited back into the Net Income, and get a cash-from-operations total. We also get Cash Flow from Investing activities reconciled, which is part of the company’s reported Free Cash Flow number, and Cash Flows from financing activities reconciled, but excluded from the reported Free Cash Flow results.
The real tipping point for Free Cash flow as reported this quarter, will be the amount of funds that will be allocated to Property & Equipment this quarter. The company has outlined a projected expense for this category of $120 million for 2011.
Last year the company had a negative ($127) million, as a result of a ($98) million charge to Property & Equipment for continued payments for the XM5 launched in Q4. It also had negative cash from operations of ($37) million as a result of an up-front payoff of an accounts payable, which would have cost 15% in interest plus fees on an expense generated in 2009.
This is a tough number to estimate not knowing the options available to the company. In feeling the company will want to put forth a positive Free Cash number this quarter, I am going to estimate between $25 -$35 million in Free Cash. The company has projected approaching $300 million for the year in Free Cash for 2011, and playing “catch-up” on this number is something it is accustom to. Last year with $150 million projected, it ended the year with over $200M, even with its substantially negative first quarter start.
Stock Price Valuation –Present $2.00 Fairly Valued, — 12 Month Target $2.66:
As outlined above in the discussion of adjusted EBITDA, Media, Communications and Entertainment companies use metrics that are based on forward looking Adjusted EBITDA, in combination with metrics reflecting the health of a company's capital structure. Sirius XM Radio in particular, has acquired a significant amount of debt in building out its business. It has only started to become profitable, with net income of $43 million for the full year 2010.
Over the past two years there has been significant improvement in the quality of the debt, interest rates paid, and some reduction in total debt outstanding. In addition to restructuring the debt by pushing it out over a longer term with better rates, the company has removed many of the restrictive debt covenants from its capital structure, and in turn, returned control of the company to its board room and management team.
The company has been rewarded by the ratings agencies for its efforts. When looking at Debt to EBITDA ratios, it has significantly improved to a leverage of 4.1. David Frear, Executive VP and CFO, has said that a debt leverage of 3.0 is the target for the company to grow its EBITDA into over the coming years. Of course the statement reflects that the company is fairly comfortable with carrying its current debt amount going forward.
Credit upgrades, progress toward attaining adjusted EBITDA growth of 35% year-over-year, and a clear goal for debt management have brought stability to the company’s capital structure, and with it, increased institutional investment and premium multiple valuations.
So let's look at valuation model using an EV/EBITDA ratio. We can start by using the company’s present stock price of $1.98 per share, a fully diluted share count of 6.530 billion shares, total debt of $3.022 billion, actual Adjusted EBITDA of $626 million, projected Adjusted EBITDA of $715 million for EOY 2011, and Current Cash of $586.7 million, all as of December 31, 2010. With these assumptions, we can calculate the company’s Enterprise Value (EV). Attaining the EV is done by adding all of the parts of the company together: Market Capitalization (SP * Total Shares) + Total Debt – Cash = Enterprise Value. Based on these assumptions we can derive that EV = [$12.9 billion (MC) + $3.022 billion (Dbt) - $.5867 billion (Csh)] = $15.365 billion EV.
This means that currently the stock is trading at 24.5 times December 31st, 2010, Adjusted EBITDA of $626M reported in the 10K on February 15th, 2011. That would be backward looking in our valuation. Looking forward and using 2011′s projected adjusted EBITDA of $715 million, the stock at 1.98 is currently trading at 21.5 times 2011 forward expectations. By many standards this is a premium valuation that the company is currently trading at.
Further assessment of its future prospects to determine if these valuations are worthy of the company are required. At 21 times forward looking EB/EBITDA, it is my opinion the company is fairly valued at $2 per share. This is why analysts such as, Barton Crockett of Lazard Capital Markets, who had a previous price target of $2, have downgraded the stock from a BUY to a HOLD in my view, but I am sure Mr. Crockett can speak for himself.
To understand the way analysts will treat the stock in their recommendations, it is important to look at a variety of risk factors to be included in their formulas. Some variables will bring premium weight to the multiple assigned, while others create a discount to their multiples applied to a variety of valuation assessments. It is important to know which valuation models are being used when listening to analyst viewpoints.
Looking at a twelve month price target for SIRI, using all the assumptions as outlined, using an increase in adjusted EBITDA of 32% for the end of 2012, yields a projected value of $943.8 million in this variable. Using this projected number, times a premium multiple of 21.5 results in an EV of $19.816 billion. Net out the same total debt and cash and the Market Capitalization is now $17.38 billion or a stock price in twelve months of $2.66 per share. This model should be run periodically updating the various components, and then applying news and events to the multiple as appropriate.
With the upcoming Conference Call on Tuesday, May 3rd, the company is going to have to increase guidance for adjusted EBITDA and Free Cash, in order to get a more beneficial valuation on its stock price in my view. Management has been conservative in the past, providing a commonly known –under promise and over deliver assessment of its future financial and operating performance. Having followed the company for a number of years now, it is my opinion that the company is on the cusp of becoming the cash generating machine that many of us have believed it would be. With growing vehicle sales numbers, a new product offering in the fall, pricing flexibility and capital expenditures falling off by the end of the first half of 2011, there is no reason for the company not to be given premium multiple valuations if it provides the necessary guidance.
For investors to receive further benefit from this very positive perspective in the short term, management will need to shine the light on these realities so that forward looking models can work their magic for continued investor returns. Otherwise it may be a long wait until execution and results alone pave the way to future gains.
Disclosure: I have reduced by 1/3 my SIRI holdings within the last 72 hours.