I recently wrote an article entitled "A Sirius Look at Subscribers" where the historical trends in SiriusXM Radio's subscriber activity were examined. It was pointed out that those subscriber metrics should be important to investors and that investors should continue to monitor conversion rates and churn carefully. Some of the comments correctly noted that I failed to consider the potential impact of SiriusXM 2.0 or the potential of Latin American markets or a potential price increase in 2012. All of this is true, all of these points are valid, each is likely to have a positive impact on revenue at some point in the future and all of them are nearly impossible to quantify without some significant guidance from Sirius management.
There were also some comments by dukeufinstu that really got me thinking. The first was:
Excellent article, well researched and written. You might want to write a follow up and explain what happens when the sub base hits 25M...take a look at the Law of Big Numbers.
It might surprise everyone.
Well, of course anyone who starts out with those compliments grabs my attention. But since I'm also a skeptic, I was wondering if Duke was pulling my leg. After all, it was only his 5th comment on SA, and there was that reference to the Law of Big Numbers. You see, back in January, Brandon Matthews had written an article on SA entitled "Sirius XM and The Law of Large Numbers" that poked fun at the way those like me looked at subscribers. But, since I enjoy discussing and looking at numbers, I pursued the dialog Duke had begun.
Let me digress for a moment. I suspect that I am like many other investors and expect Sirius to continue adding subscribers at a very healthy rate for the foreseeable future. I know that at some point the growth curve should flatten out and that the number of new subscribers will balance the number of subscribers canceling and we will reach a point of equilibrium. I am also thinking the time for this to happen is fairly far out into the future. But, how far out is it and what are the factors we should consider? Well, back to Duke's question...
Ideally, I wanted to model the growth, bring in some computer programming contacts that could let me look at the Sirius business model and its sensitivity to installed base of self-pay subscribers, US new car sales, penetration, conversions and churn. Or ask friends of mine who still remembered their calculus to solve for the second derivative (or whichever derivative it was that gave one the maximum). Or I could try and plot the growth of subscribers to see when Sirius might reach 25 million subscribers. Then again, I occasionally over-think these things and Duke quickly pointed this out as he wrote:
"If you look at 25 M subs with a churn of 2% a month, you will see that the company will lose 6M subs a years. Now take 15M auto sales a year with a 65% penetration rate. That gives you 9.75 M subs being generated. Multiple that by a 45% conversion rate and you generate 4.39M new subs. You add 4.4M new subs and lose 6M. What happens to the share price? "
Part of my reply was "It [the share price] obviously would have stopped growing long before then, but it would still be up from where it is today. At that point it [the company] would be relying on price increases to boost earnings, it's P/E would fall back and it would mirror other mature, cash generating companies that pay dividends to keep shareholders happy."
Duke replied, "You have the correct answer. The stock price begins to fall when Wall Street sees that the growth begins to slow. Forget all the fancy math. Take 20M subs, and do the same math...not good. Today we have 16M self pay subs and will add 1.4M per year. When do we hit 20M? When does the trouble start for the stock? There is your next article."
Duke is right on target on a number of points. First, it's really not all about fancy math, although I still wanted to know when the subscribers are in equilibrium, or when the self-pay subscriber additions coming from the OEM model would equal losses due to churn. The math is only high school algebra for most of us, and if I use an arbitrary annual OEM new car sales level of 16 million, the formula is:
(16 million new car sales per year x 65% penetration x 45% conversion) = (Average Number of Self-pay Subscribers x 2% churn x 12 months)
Self-pay subscribers = (16 million x .65 x .45 ) / (.02 x 24 ) = 19.5 million
As I noted in my earlier article, Sirius reached 16.8 million self-pay subscribers at the end of the first quarter. Are we now less than 3 million self-pay subscribers away from equilibrium? Well, adjusting vehicle sales, penetration, conversions and churn will all give different values for equilibrium. If GM, Ford (F) and Chrysler pick up market share from Toyota (TM), Honda (HMC) and Nissan (NSANF.PK) as a result of production interruptions caused by the tragedy in Japan earlier this year, then maybe there will be some changes to the penetration or conversion percent, but it won't alter the basic thesis. And there should be additional subscribers outside the OEM channel, including used car re-activations, Internet subscribers and smartphone usage or there could be improvements due to 2.0 or there could be negative effects of a price increase. I'll leave it to the reader to change the various factors and come up with their own answer.
I don't know if Duke was right about the numbers surprising everyone, but they sure surprised me. And even though I still don't know how many years we are from equilibrium and I still want to do some fancy math, he's right about two other points. Wall Street will react negatively to slowing growth. And, I have my next article.
Disclosure: I am long SIRI.
Additional disclosure: I have sold covered call options expiring January 2012 against most of my SIRI positions. I may also write call options against my uncovered positions at any time. I have no positions in any of the other companies mentioned in this article.