Sirius XM And Hidden Opportunities

Dec.27.11 | About: Sirius XM (SIRI)

At the Liberty Media Corporation (NASDAQ:LMCA) 2011 investor and analyst meeting on November 17th, Sirius XM (NASDAQ:SIRI) CEO Mel Karmazin spoke for almost half an hour about the company he runs. Obviously, much of the talk was focused on the well-developed OEM channel that Sirius dominates and where nearly two out of every three new cars sold in the U.S. comes with a Sirius satellite radio installed in the dashboard. Part of that talk also focused on the future and where there were potential opportunities for diversification and expansion outside the OEM channel.

The most significant "new" market opportunities would appear to be smart phones and vehicles with satellite radios whose owners were not current subscribers. It is probably a useful exercise to examine these opportunities, first addressing the market represented by cars with inactive, factory installed Sirius and XM receivers.

At the conference, Karmazin noted that there are currently about 40 million vehicles with factory installed equipment. Less than half those are subscribers. The company has had programs to address Certified Pre-Owned (CPO) vehicles for years, and earlier this year announced a program to encourage dealers to offer free trials in any used car with a factory installed radio sold through participating dealers.

According to Karmazin, within three years "the enabled universe of cars with a satellite radio in them will exceed 70 million." If Sirius is able to grow subscribers by 8% per year, that still leaves more than 45 million vehicles with installed radios that are generating no revenue for Sirius. The question investors must ask is how successful will Sirius be trying to monetize this asset.

Many of these inactive radios will be in cars still with the original owners. These are owners who have already decided not to become self-pay subscribers. Some may have made the choice after the free trial and others may have decided after becoming self-pay subscribers and subsequently decided to cancel. They are unlikely to suddenly decide it is a service that they are now willing to pay for.

Others are likely to have purchased a used car sold under one of the programs that offered free trials and made similar decisions to new car owners. They either failed to convert or churned out of the self-pay population. Similar to the new car owners, they are also unlikely to become self-pay subscribers after terminating their service.

There is a third set that bought their cars before the used car trial programs were instituted or in private transactions outside of these programs. These are customers that Sirius has tried to capture in the past by "lighting up" their radios and providing the service for free for a period of two weeks and offering limited time promotions for $5 per month. Sirius has presented no evidence of the success or failure of these programs. That is certainly not definitive proof that the program is a failure, but it does suggest that success has been limited. If it had been reasonably successful, the company would likely have been informing investors and analysts.

One intriguing idea shared by Karmazin at the Liberty meeting was the possibility of offering a free service where the stations would carry ads and the number of stations offered would be limited. This type of program has the potential to generate additional advertising revenue and has the potential to make Sirius more valuable as a distribution channel to certain content providers. It also has the risk that it could cost Sirius some of its current self-pay subscribers.

One last note on inactive radios. Sirius radios capable of receiving the expanded features and content of 2.0 are not currently being installed on OEM models. During the Q2 conference call last summer, James Meyer, Sirius president of sales and operations, said:

In fact, we expect to be able to announce, by year end, launch plans for at least one of our OEM partners to begin factory implementation of 2.0 features as early as next year.

Hopefully, the first 2.0 radios will appear in cars during 2012, but time is running out for the announcement to take place by "year end." Obviously, this doesn't mean that 2.0 won't be appearing in the 2013 model year dashboards, but it does indicate that the OEMs may be a bit slow in adopting the new platform. And, unfortunately, many of the features and functions designed to improve the competitive position of Sirius simply won't be available in most of the 45 million cars with inactive radios.

Regarding smart phones, Karmazin noted that "There are 95 million smart phones on the road today." These phones can tie into the aux-in jack on many car dashboards. They can also access Sirius content. And although this is not something new, the idea that Sirius management is openly discussing this opportunity is refreshing.

When Meyer was discussing 2.0, he said "This upgrade will first be available to subscribers late this year when we make two new-generation radios available at retail." So far only one radio has been made available and there are very few days left in the year. A new platform combining hardware and software changes is never easy to build, but investors tend to get excited about the future possibilities and the potential profits.

Major League Baseball scouts and general managers get excited when they talk about their minor league prospects and how much potential they have. Ardent baseball fans often get caught up in the excitement even though they are very familiar with how often prospects are over-hyped and how few of these prospects actually realize the potential many had forecast. On rare occasions, the fans get to follow the player's development into a superstar. More often, these fans are disappointed when the prospect turns into a "bust" and never makes it to the major leagues, or if they do arrive, never live up to the hype.

Karmazin spent time talking about potential opportunities for Sirius. How excited should Sirius investors get about these potential opportunities? Are they getting caught up in the hype or will Sirius hit a home run and have investors wildly cheering about successful programs, significant new revenue streams and higher share prices?

Sirius has placed some interesting ideas in the minds of investors. Are used car programs, "lighting up" inactive radios, smart phones and free ad-based stations meaningful parts of the company's future? As the New Year approaches, Sirius investors are still waiting for the formal delivery of the second radio model and the announcement of the OEM that will be installing a 2.0 capable system. Will Sirius investors be rewarded with new revenue channels that achieve superstar status or be disappointed if a program turns into a bust?

Disclosure: I am long SIRI.

Additional disclosure: I am long SIRI. I also have $3 January 2012 covered calls against most of my Sirius position. I may initiate (or close) a buy stock/sell option position in Sirius, discussed in another article, at any time. I have no positions or plans to trade any of the other stocks mentioned in this article in the next 72 hours.