Sirius XM Bulls Just Getting Started

| About: Sirius XM (SIRI)

Iconic American broadcaster Sirius XM (NASDAQ:SIRI) recently was driven up 4.65% by the close of recent trading. In my view, this is just the start of a bull rise, as the company is proving itself to be more protected against a downturn than what market sentiments previously implied. Management is committed to growing the differential between return on invested capital (ROIC) and the weighted average cost of capital (WACC) through value-creating mergers and product offerings.

Price increases coupled with continued benefits from merger synergies have yet to be fully factored into the stock price. As the company is a volume leader, it stands to benefit further from management's clarification over business strategy.

As for proving itself to be more protected against a downturn, note that Sirius is raising its guidance by an impressive 1.6M subscribers for the year. This absolute growth is up 13% from last year and will lead to sequential improvement in free cash flow generation. Additionally, the subscriber base is experiencing accelerating growth in the midst of economic stagnation and considerable competition. In the second quarter of 2011 alone, Sirius gained 452K customers and now has an impressive 21M paying subscribers. New programs like "Real Housewives Radio", along with continued success in music, sports, talk, news, entertainment, weather, and traffic, will help sustain broadcasting efforts.

Add new application for Android, the iPhone, and Blackberry and you have one company well positioned for future growth in media. At the 2Q11 earnings conference, the CEO mentioned:

Considering the pricing restrictions we were faced with, I'm very pleased we were able to grow our revenue by 6% to $744 million, which was the highest revenue recorded in any quarter by satellite radio. Once again, we did an excellent job in controlling our costs. Our cash operating expenses only increased 2% in the quarter. We are particularly pleased that while we are providing the strongest content lineup in the history of satellite radio, we are doing it with less cost than last year in absolute dollars and at a lower percentage of our revenue. This is obviously not the case for satellite and cable TV companies.

The synergy of the merger has allowed us to do this, and it will continue as contracts come up for renewal. As part of SiriusXM 2.0, we will be increasing the programming we provide with more channels, and we will do this with less programming expense in 2011 than in 2010. The adjusted EBITDA growth of 20% is very impressive. Our $185 million in the quarter is also a record quarter for us. Revenue is growing faster than expenses, resulting in an improved margin of 25% in the second quarter. We believe our margins, when we are a mature business, will exceed 40%. To give you an idea of our progress in driving these adjusted EBITDA margins, our first half margin was also 25% in 2011 and up from 23% in the first half of 2010, up from 20% in the first half of 2009. And before that, in the first half of 2008, we had negative 11% before the merger of Sirius and XM. Q2 2011 is the 11th quarter since the merger, and every quarter has delivered double-digit adjusted EBITDA growth year-over-year.

While the planned price hike of $1.50 for January 2012 might sound reminiscent of Netflix's (NASDAQ:NFLX) failed strategy, the context between the two are worlds apart. For example, movie subscribers do not require a special medium for optimal program viewing. Radio subscribers, on the other hand, prefer one channel over another and become loyal to certain stations. Additionally, an incremental 11.6% price hike off of $12.95 (as opposed to Netflix's 50% price hike) will have an insignificant effect on drop-off. The market has thus yet to fully appreciate the benefits Sirius will gain from this change.

The radio broadcaster would have increased prices earlier, had the FCC not imposed certain restrictions in the merger order. The FCC is now in agreement that there is no longer a need to ban increasing base prices.

Under newfound freedom, Sirius stands to improve margins and grow EBITDA by a CAGR of as much as 31% over the next four years. The top-line will further be improved by a macro recovery and, in particular, an improving auto market. 65% of all new vehicles manufactured for the United States come equipped with either XM or Sirius radio - a stunning statistic that will sustainably grow shareholder value. As free cash flow was up 53% y-o-y in the second quarter, Sirius has plenty of capital to work off of. Shareholders may even be able to see buybacks in early 2012 and a dividend yield, which is currently not provided.

Consensus estimate for EPS are that it will grow by 500% to $0.06 in 2011, and then by 33.3% and 37.5% in the next two years. I anticipate revenue growing by 7% to $3B in 2011 and then by 12.1% in the following year. Higher ARPU and improved marketing power will help to offset any increases in costs. In light of this, concerns over a double dip will drive high risk-adjusted returns. Investors optimistic about the company's fundaments should consider buying - for, in my view, the bull market is just getting started here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.