AutoNation Reports Strong Q4, Offers Clues To Sirius XM Deal

Jan.27.12 | About: AutoNation Inc (AN)

About a month ago Sirius XM (NASDAQ:SIRI) and Autonation (NYSE:AN) announced a deal whereby any satellite radio equipped used car sold by AutoNation would come with a three month trial to Sirius XM.

As I have written about several times, these used car deals are really beginning to pay off for Sirius XM, as they add a new pipeline of subscribers that the company until now has had difficulty tapping in to.

The first thing Sirius XM investors need to understand is that these promotional subscriptions are not counted as subscribers. It is only after the 3 month trial period, and if the consumer keeps the service, that the company counts them in their subscriber pool. Thus, a vehicle sold today may become counted as a subscriber 3 months from now.

The next thing to understand is that Sirius XM is making an investment into each promotional subscription in hopes that at least a certain percentage of these trial subscribers will convert to self paying subscribers.

Lastly, there is very little transparency into these deals. We do not know the fees involved, and the company gives precious little data on the numbers involved. Every once in a while we get a nugget of information, and while it may seem small, when combined with other data, we can begin to build a model.

Sirius XM has at one point stated that they see the percentage of conversion of these trials to self paying status in the "mid-thirties." That was a nugget of information from Sirius XM. Now we can use other sources to make some decent assumptions.

In my opinion, for every new car sold, we can assume that 1 quality used car sells. I define a quality used car as one that is 3 years old or less, which increases the odds that such a car is equipped with satellite radio. Through other sources I have seen that the quality used car market has about 45% of the cars sold equipped with Sirius XM. This means that for every 100 cars sold we will see 45 of them as satellite equipped.

Taking it a step further, we can crunch some numbers:

  • 45% penetration
  • 35% take rate

100 cars translates to 45 with satellite radio and thus trial subscriptions. With a 35% take rate we can assume that Sirius XM will garner about 16 subscribers. Simply stated, for every 100 used cars sold by Autonation, Sirius XM will gain 16 subscribers.

In 2011 Autonation sold 171,000 used cars. If they had a deal with Sirius XM last year, they would have delivered about 27,000 subscribers to Sirius XM. Should the company see 10% growth in 2012, we can assume that AutoNation will deliver about 30,000 subscribers to Sirius XM this year (or about 7,500 per quarter).

While this may not seem huge, consider that AutoNation represents a small portion of the market. Sirius XM has similar used car deals on a much larger scale with GM, Nissan, and Chrysler. In fact, they likely have deals in place with about 3,000 (or 15%) dealerships at this point.

If a quality used car sells for every new car that sells, and if the sector sells 14,000,000 cars in 2012, the numbers get impressive:

  • 14,000,000 * 45% penetration = 6,300,000
  • 6,300,000 * 15% dealership participation = 945,000
  • 945,000 * 35% take rate = 330,750
  • 330,750 subscribers / 4 quarters = 82,687 subscribers per quarter.

These are significant numbers that will help this company grow the subscriber base during 2012.

Now, as with anything, there is another side of this equation to look at. I get a lot of criticism for presenting the flip side of the equation, but these are indeed REAL considerations that must be made. Management makes these types of evaluations, so it only makes sense that investors do as well. In fact, the issue I am about to discuss could be a substantial reason why Sirius XM isn't just signing these deals with everyone today.

Deals like this cost money. Garnering subscribers costs money. If a company grows too fast, it could throw a wrench into the workings of other metrics. These used car deals carry Subscriber Acquisition Costs (SAC) as well as EBITDA.

Lets assume that Sirius XM is paying a spiff of $20 for each of these trial subscribers:

  • Those 945,000 would carry a cost of almost $19,000,000. That is a direct cost that would be a drag on EBITDA.
  • If Sirius XM had deals in place with every company, they would be looking at 6,300,000 trial subscriptions at a cost of $126,000,000! What would happen to EBITDA if the company grew the used car sector that quickly? It would be crushed!
  • Now let's look at SAC. The 945,000 cars would develop into 330,750 subscribers, and the SAC per gross addition for the used car deals is $57. As you can see, the SAC of these deals may fall right into the range that the company currently pays.
  • While many would call these deals SAC friendly, they are more likely than not SAC neutral. Thus, if you are looking for a large improvement in SAC from these deals, you may want to re-run your model.

All in all Sirius XM is marching down a path that provides a subscriber bump at costs that are not going to take too big a bite out of ARPU. This shows a management style that is about controlled growth without taking a toll on the bottom line. That is a strategy that works fine, as long as investors have their expectations in the right place. Essentially those that are overly bullish on growth may be disappointed, while those that want a constant, consistent, and managed growth may be happy. In other words, some may need to temper their exuberance about Sirius XM to account for the measured steps Sirius XM management is taking.

Disclosure: I am long SIRI. I have no position in AutoNation.