A Deeper Look at Sirius XM's Used Car Deal With GM

| About: Sirius XM (SIRI)

One of the biggest opportunities for Sirius XM (NASDAQ:SIRI) over the past years has been the number of satellite radio equipped cars on the roadways that are not currently subscribers. There are literally millions of vehicles with satellite radios that remain idle, and thus generate no revenue for the company. Adding to the frustration is that the company has invested a lot of money into getting that car equipped in the first place.

This week Sirius XM announced a used car deal with General Motors (NYSE:GM) that changes the whole dynamic going forward, This deal literally gives Sirius XM a second chance at getting that idle radio activated.

Sirius XM has had Certified Pre-Owned (CPO) deals in place. The CPO deals gave consumers a three month promotional subscription. The problem has been that dealerships are more worried about the sale than letting consumers know about the promotion. What transpired is that consumers were oft not even aware that their satellite radio was active.

This new deal encompasses not only CPO cars, but any used car regardless of brand sold at over 1,000 participating GM dealers. The language of the press release would seem to indicate that there is some sort of kickback, or incentive for these dealers to get people signed up for a satellite radio promotion. That is a good thing. Sirius XM finally has a way to know about satellite equipped cars after the initial owner is done with them.

Sirius XM has been frustrated for years at finding a way to know who owns used cars equipped with satellite radio. The company has approached insurance companies, and even cut deals with major used car players like CarMax. The success has been limited, but this new type of deal with GM could be a game changer. Finally Sirius XM will have the valuable name, address, phone number and even email address of a consumer buying a used satellite radio equipped car. With this information the company can now market to consumers in hopes of getting them to become self paying.

This GM deal is also likely just the beginning. Ford (NYSE:F), Chrysler and others may soon follow suit, bringing the number of participating dealers to several thousand. For now, let's work with 1,000 and dig deeper into exactly how this deal will become a major driver for Sirius XM.

First we need to gauge the size of the used car market, Typically it is about 3.75 times bigger than the new car market. In May of this year about 1 million new cars sold. The number of used cars came in at about 3.8 million. Right off of the bat the potential for promotional subscriptions in the used car market is actually bigger than that of the new car market. Sirius XM reports that roughly 60% of new cars sold have satellite radio. If 1 million cars are sold, there will be about 600,000 cars with promotional subscriptions. If 25% of used cars have satellite radio, and 3,8 million used cars sell in a month, it stands to reason that about 950,000 of them will have satellite radio and can be potential promotional subscribers.

Before we get to carried away, we need to throttle back and consider that at this point we are only talking about 1,000 GM dealers. My research indicates that between 25% and 35% of the used cars at a dealership are equipped with satellite radio. This means that if these 1,000 dealers sell two cats per day (a conservative assumption) we would be looking at 180,000 cars, of which 45,000 would be promotional subscribers. If the company can convince 45% of those to become self paying, matching their take rate on new car conversions, we would be looking at an additional 20,250 net subscribers per quarter. How substantial is that? In Q2 the company netted about 375,000 net subscribers. An additional 20,000 would have brought that total to nearly 400,000. This would have brought the churn metric down by nearly a tenth of a point and improved ARPU. And while the kickback would have added to the money spent on subscriber acquisition, it would have likely brought the average down. Now consider what happens when we add 1,000 Ford dealers and 1,000 Dodge dealers to this equitation. What happens when Toyota (NYSE:TM), Nissan, Hyundai (OTCPK:NSANF) and Honda (NYSE:HMC) join the fold? The numbers will scale quickly.

The next item of consideration is grasping when this impact begins to unfold. I have a unique way of looking at the OEM channel for Sirius XM. We often hear the term "Promotional Subscriber," but many do not realize that promotional subscribers actually fall into three categories. Those categories are "leading," "point of sale" and "trailing." Only the leading and point of sale categories add to the subscriber numbers reported by Sirius XM. The trailing category (companies like Toyota, Hyundai and all CPO programs) can only become a subscriber after the promotional period, and only if the consumer elects to become a self paying subscriber. Leading promos (companies like Ford, Chrysler, Mercedes and BMW) are counted at manufacture, and point of sale (companies like GM and Honda) are counted when the car is sold.

These used cars will fall into the trailing category. This means that it will take about four months from the sale of the car to potentially become a subscriber. Simply stated, a satellite radio equipped used car sold in July will be an "uncounted promotional subscriber" until October, and will only be counted at that time if the consumer keeps the service. Thus, the subscriber impacts of this new GM deal will not be realized in a meaningful way until Q4, but the kickback costs will be an impact in Q3. This is something investors should bear in mind.

I often see Sirius XM investors get overly excited about the subscriber number picture. This often sets them up for disappointment as the quarterly numbers are announced. This deal is good, but it is just the beginning, and it will take more of these deals and a few quarters to begin to play out. Just remember that patience is rewarded.

Knowing that this type of deal exists, and now understanding the timeframe that it will take to play out gives savvy investors an advantage. Currently Sirius XM's stock price is depressed. This could be a perfect opportunity to buy in. The company will now be virtually forced into raising guidance on subscriber numbers at the Q2 conference call in August. Last quarter CEO Mel Karmazin did a masterful job during the call, and the street showed appreciation in a big way. This type of deal with GM will certainly be a point of focus that the company will gladly discuss.

Disclosure: I am long SIRI.