A Deeper Look At Sirius XM's Price Increase

| About: Sirius XM (SIRI)

Last week Sirius XM Satellite Radio (NASDAQ:SIRI) investors heard the long awaited news that the company would be increasing prices beginning January 1, 2012. At this point the company has only announced a price increase to the "base service" from $12.95 per month to $14.49. The increase is only $1.54 per month, but over time this will translate to millions hitting the bottom line.

Before we get to excited, we need to look at the dynamics of how a subscription business model works. This will begin to tell the story of when Sirius XM investors can expect to see additional revenue make a meaningful impact.

The first thing to consider is that the immediate impact of a $14.49 price point will be felt by new subscribers to the service first. The company will add between 500,000 and 1,000,000 new self paying subscribers in a year. These new subscribers will pay up the full $14.49 fee. This will represent only 3% to 5% of the self pay base for 2012. Obviously this will help the Average Revenue Per User (ARPU) line item, but the numbers are still small ... At least initially. As the years pass, the pool of new subscribers paying the full fare will increase.

Existing subscribers have a few dynamics at play. Those that do not have their contract expire until after the new year will not be paying the additional cost until they are up for renewal. This means that the price increase could take quite some time until it is fully implemented across the existing subscriber base. Someone under a three year contract ( a small minority of the subscriber base) will not pay the additional costs until as late as 2015. Further, the company will give existing subscribers the opportunity to lock in existing rates prior to January 1, 2012.

The first impact of the Sirius XM price increase will be seen in the cash line item and in the deferred revenue line. When a subscriber pre-pays for service, the company is getting cash up front. This makes the cash line look good, and is very good for free cash flow. The down side is that these pre-payments are booked in deferred revenue (a liability). Deferred revenue is a liability because the company (Sirius XM) owes the subscriber service. In essence there is a contract between the consumer and the company. The consumer has delivered their part of the contract (cash), while the company has not yet delivered their side of the deal (service). The pre-payment monies sit in deferred revenue until Sirius XM delivers their side of the deal. On a one year pre-payment the company will remove 1/12 of the pre-payment each month from deferred revenue and place it in the revenue line as they deliver service. Thus, money received on a 1 year pre-payment made in September of 2010 is just now being booked in the revenue line.

One way for investors to track the impact of a run of pre-payment activity due to a pending price increase is to monitor the deferred revenue line in Q4 of this year compared to previous and pending quarters. A substantial bump would be an indication that cash is being infused into the company in the manner of pre-payment.

The interesting dynamic here is that the new price point may be at such a level as to not cause a run on the company with pre-payments. With the time/value of money, consumers may not be compelled to pre-pay. If this is the case, the company coffers in terms of cash may not swell to levels some are anticipating. This is not a bad thing, in fact, it may be seen as a good event in that the price increase is not enough to cause worry on the part of consumers, but is big enough to make a meaningful impact.

While most reports to date have discussed the additional $1.54 per month, not many have delved into what additional pricing the company is capable of. The company has not revealed whether or not there will be a fee for some of the additional satellite radio 2.0 services. What we do know is that many of the capabilities in Satellite radio 2.0 will be seen on the Sirius XM Internet Radio service.

Currently Sirius XM charges a $2.99 premium for Internet radio listening. The use of the Internet side of the business has not been a huge segment of the subscriber base. Simply stated, the percentage of subscribers paying the additional $2.99 per month has been small. With the advent and then proliferation of smart phones, more subscribers have begun to opt for this feature. With Satellite Radio 2.0, we could see a healthy bump in this category. The reason is as simple as the added capabilities that satellite Radio 2.0 delivers. With the ability to get content "On-Demand," the ability to access more content, and the ability to get the best radio content on a mobile platform, the value of the Internet feed will be higher.

Thus, Sirius XM can in effect get more revenue from the existing subscriber base even if those subscribers are not yet paying the new $14.49 "base price". In effect, by making the Internet feed more compelling, the company can drive users to adopt a premium tier above that which they are currently subscribed. This type of action will help the ARPU line in a more immediate fashion. It is even possible that the company offers a tiered Internet pricing structure A base price for someone who does not want additional services, and a higher price for those that do. Now what we have is a dynamic that I have discussed in previous articles regarding Sirius XM pricing.

On top of these items we have the company doing something else that is quite compelling for investors in Sirius XM. Recently Sirius and GM (NYSE:GM) hooked up to offer a 1 year promotional subscription which includes XM Premium rather than the standard XM service. This type of promotion allows the consumer to experience the entire service rather than a less expensive tier. By allowing consumers to get everything, the company has a much better chance at keeping subscribers on these higher priced options when it comes time to become a self-paying subscriber.

The effect is that the price increase announced by Sirius XM may well get lost in the new way the company will be conducting their business. The existing subscriber will be thinking less about the increase, and more about the new and compelling capabilities delivered by Satellite radio 2.0.

In summary I see a new pool of excitement coming over the next 12 months for Sirius XM investors. This excitement is not created by the additional $1.54 per month, but rather the ability of the company to market the Internet and premium tiers of service in ways they simply have not done before.

Certainly these impacts will take some time, but investors can take solace in knowing that Sirius XM has reiterated their 2011 guidance and offered up guidance for 2012 that looks even better.

Disclosure: I am long SIRI.