Monday was supposed to be an exciting day for Sirius (NASDAQ:SIRI) investors. After the Nasdaq's announcement last Friday that Sirius would be officially joining the Nasdaq-100 index (the basis of popular investments such as the Nasdaq Powershares QQQ trust (NASDAQ:QQQ), Sirius fans had the whole weekend to discuss the repurcussions of Sirius' upcoming addition to the index. One Sirius fan even said the announcement could send Sirius up to $3 or $4 within two weeks (a potentially stunning 30% to 80% gain from present levels).
Of course, after a small gap up Monday, Sirius retraced and closed the day off a penny, only mildly outperforming the market as a whole. While most level-headed analysts would have realized the Nasdaq-100 announcement wasn't a big deal, it was still a surprise to see the stock trade down after this allegedly fantastic news. Since the QQQ ETF has roughly $24 billion under management and assuming that Sirius will have roughly a 1% allocation in the QQQ post-addition, this means that QQQ will have to buy roughly $240 million of Sirius stock. Given that Sirius trades nearly 100 million shares a day on average, the QQQ will have to buy somewhere in the neighborhood of one day's worth of Sirius' trading volume. That should be good for a small bump in the stock price, but in the grand scheme of things, it's nothing. And we didn't even get the small bump Monday.
However, the market has been trading Sirius on perception and not reality for months now; and it is curious that the market so readily shrugged off the announcement. Positive fundamental news has been harder and harder to find out of Sirius recently, so bulls have been looking to increasingly flimsy catalysts for encouragement that the stock could go higher. I figured the end was near when articles started suggesting that Sirius should buy Myspace and that this would incredibly double Sirius' share price, adding more than $8 billion to Sirius' market cap. You read that right, somehow Sirius purchasing Myspace, who recently sold for less than $40 million, was supposed to add $8 billion to Sirius' market cap. Crazy, right?
Clearly when this is the sort of stuff Sirius bulls are running with, the end of the rally is near. Monday's (non) reaction to the index addition confirms that the market has run out of starstruck speculators willing to buy Sirius' increasingly overvalued shares. In short, the greater fool theory has played out perfectly, and the people buying the stock at this heights appear to be the final dupes who get left holding the bag. When the market sells off a stock on a piece of genuinely good news, one must look out below; any bad news will cause the stock to get dumped. All the weak-handed speculators who bought the stock over $2 are going to scramble as soon as it becomes clear that the optimistic forecasts of $2.75 or greater just aren't going to play out.
The thing that really struck me is that some of the analysts with aggressive price targets are calling for Sirius to raise guidance on the basis that this move could add 25 cents to the share price. Why should anyone assume that earnings are going to be better in the coming quarter? In case you hadn't noticed, the economy has been hitting significant unexpected economic headwinds in the past few months, highlighted by the "surprise" rise in unemployment last week. There's no guarantee that upcoming earnings will beat (or even meet) expectations given that the economic news has been one unending stream of weaker than expected data releases in the past month.
Sirius cheerleaders have already baked a strong quarterly earnings release into their analysis and in addition, they're forecasting some pretty unrealistic other catalysts into their Sirius to $3 this fall mantra. One of these dubious assumptions is that the automotive industry will extend its rebound. With the economy rapidly slowing, this belief is questionable. Unemployment is aggressively rising again, with private sector job creation looking downright pathetic?
As SA Contributor The Inflation Trader noted in his fantastic article on the unemployment situation, when unemployment rises 0.5% in the U.S. (we just hit this threshold last week), it has always risen at least an additional 1% after that. So at minimum, we're looking at a 10.1% unemployment rate around the beginning of next year. I have trouble believing all those newly unemployed folks are going to be rushing out to buy new cars and/or extend their Sirius subscriptions. Satellite radio is not a necessity, if people lose their jobs and have to choose between food, gas or satellite radio, (most) people will cancel their radio subscriptions. With the US economy threatening to enter a recession, Sirius' doubled-up leverage to the economy (through both car sales and disposable income) will result in a powerful contraction in Sirius' revenues.
Sirius fans also point to the upcoming Satellite Radio 2.0 as a revolutionary engine of transformation for the company. But its foolish to bank on an as of yet unseen future product to boost the company when it is staring down increasingly fierce competition right here and now. Between a newly well-financed Pandora (NYSE:P), an aggressive Clear Channel (NYSE:CCO) who is set to launch a dynamic commercial-free streaming radio product, the competition is here now. And the competition won't wait for Sirius to finish working out the kinks of Satellite Radio 2.0.
Additionally, Sirius investors are counting on a potential price increase for subscriptions to boost revenues. As the economy slides toward (or into) another recession and jobs continue to wither away, its hard to see how a price increase is going to increase Sirius' bottom line. Again, Sirius subscriptions are not an inelastic good like food or gasoline that people will buy regardless of their economic health; when the economy turns south, people will start canceling in droves, particularly if Sirius tries to hit its users with an ill-timed price increase.
The simple truth is that unless Sirius were a fantastic growth company, its stock is stupendously overvalued. At a triple-digit trailing P/E, an (optimistic) forward P/E in the mid-30s, an expensive PEG radio (1.45) and an utterly stunning price/book ratio (30), any fundamental analyst would tell you to run far away from Sirius' stock. For a company that has consistently run large losses since inception punctuated by one just slightly better than break even year (2010) during the height of the alleged economic recovery, its hard to understand the market's willlingness to throw a $8 billion+ market cap on the company. With Sirius' subsciber revenue, operating margin and sales growth all stalled out (see graphs here), it seems likely that Sirius will return to its money-losing ways as soon as the economic tide turns.
While it's tempting to slap a $0.00 price target on Sirius shares, as it is hard to see the company's $3 billion+ of debt remaining serviceable as the economy weakens and competition eats away market share on all fronts, I'll be charitable and say Sirius might be worth a buck/share or so. The rest of the valuation is all fluff. As Jim Cramer said:
It's (Sirius) owned by really bad hands. It's owned by people who are flippers and traders and penny stock guys and I don't like them as my colleagues when I own a stock.
When short-term novice speculators figure out that they've been taken for fools and that there aren't any more dupes left to bail them out at higher prices, the selling will coming quickly and relentlessly. As the unemployment rate returns to the 10% range, car sales fall and Sirius finds itself overcome by blistering competition on all fronts, we're likely to see cut guidance as the company's short-lived streak of profitability abruptly ends. While its too early to tell if Sirius can even survive its tremendous debt load, it's clear, however, that at a $8 billion market cap for a company that produced $79 million in net income for investors last year, Sirius stock is shockingly overvalued. When even good even news such as an addition to a major index results in Sirius shares going lower, it becomes clear that Sirius' shares are about to nosedive when actual bad news hits the wires.