SiriusXM: The Good, The Bad And The Ugly

| About: Sirius XM (SIRI)

Clint Eastwood starred in The Good, The Bad and The Ugly in 1966. In 2012 he starred in a Chrysler Super Bowl commercial about the revitalization of Detroit and the U.S. auto industry. This week SiriusXM (NASDAQ:SIRI), a company that has its performance closely tied to the auto industry, released its 2011 results and issued more complete and updated guidance for 2012. Its conference call and earnings release had some good, some bad and some ugly aspects.

Before discussing the good, bad and ugly, let's get the revenue issue out of the way. Sirius came in with $3.01 billion in revenue, slightly exceeding the $3.0 billion guidance. However, the company missed the Street estimate of $785.5 million for the quarter, coming in at $783.7 million. While I don't consider either exceeding guidance or missing the Street estimate significant, Reuters apparently thought missing the estimate was worthy of the headline 'Sirius revenue misses estimates'.

On the bad news side of the ledger, investors should be disappointed that net new subscribers are projected to grow by only 1.3 million. This number is not only below The Street consensus of more than 1.5 million, but it is also significantly below the 1.7 million net adds in 2011. Investors looking for a silver lining may recall that 2011 guidance was initially for 1.4 million net adds before it was increased to 1.6 million in early August of 2011 and then exceeded the revised guidance. Will the same thing happen in 2012?

There was more bad news on the subscriber metrics. The news could be characterized as downright ugly. The conversion rate finished 2011 at 44.6%, down from 46.2% in 2010. The conversion rate rounded to 44% in Q4. And the really ugly news is in the self-pay monthly churn for 2012, projected to rise to 2.1%. Although this percentage may seem small, 2.1% per month means more than 4.5 million cancellations, and probably closer to 5 million. That's a lot of self-pay subs that need to be replaced.

There was also good news. 2011 ended with nearly 4 million paid promotional subs, an increase of 0.5 million over year end 2010. And the total number of trials -- paid and unpaid -- also increased significantly to finish the year at 5.4 million, up from 5.1 million at the end of Q3 and 4.3 million at year end 2010. This is the pipeline for new self-pay subs and revenue growth.

In a recent article I noted that Sirius was building up a large cash balance. I wrote that I expected management to face some difficult questions from the analysts about what Sirius intended to do with the cash in light of prior comments by Sirius CEO Mel Karmazin. He had said that he would like to keep net debt to adjusted EBITDA at about 3x, even if it meant taking on additional debt. A couple of comments during the conference call painted a somewhat different outlook.

On the call Karmazin backed away from his net debt to EBITDA objective and even talked about paying down debt:

Our ending cash balance in 2012 should be about $1.5 billion or about $1.2 billion if you assume we call the 9 3/4% notes this September. And our gross leverage will have fallen to under 3.2x.

There is an opportunity for the Board of Directors to consider a return of capital to shareholders beginning later this year. The board has not taken up this topic, so obviously no decision has been made as yet.

The above referenced 9 3/4% notes are Senior Secured Notes due September 1, 2015. Sirius CFO David Frear later discussed the growing cash and gave a bit more detail on the leverage:

As adjusted EBITDA grows and working capital flows improve with the price increase, free cash flow will expand over 70% to $700 million for 2012. Based on this guidance, the company's liquidity profile will improve dramatically. Cash will expand to nearly $1.5 billion and net debt to EBITDA will fall to about 1.8x. During the course of the year, we will begin to evaluate returning capital to shareholders through dividends or stock buybacks. We expect to discuss our plans with you later in the year.

These comments essentially diverted any questions about what the company would be doing with cash, pushing the decisions off to the board room. This was disappointing since I was looking for more insight into the use of cash, especially as it pertained to Liberty Media's (NASDAQ:LMCA) ownership interest in Sirius. Perhaps Liberty will shed some light on the issue at its conference call later this month.

Regardless, the cash flow and cash balance, while not a new revelation, are positives for Sirius. Cash is King. It gives companies the opportunity to retire debt, address internal needs, make acquisitions and return capital to shareholders. And the cash is projected to continue to grow in 2012 and beyond. Karmazin said:

...let me just say that I'm very pleased about our prospects for growing free cash flow rapidly over the next few years. Not only do we expect continued expansion in our revenue and adjusted EBITDA, but we also expect to deliver most of this adjusted EBITDA as free cash flow.


Since the stock price finished the day unchanged, the market has apparently evaluated the earnings report, guidance and conference call a non-event. Sirius will continue to grow, but questions will remain about whether it will grow quickly enough to justify its P/E ratio. The low subscriber guidance for 2012 was somewhat softened by Karmazin's comment, "Our net subscriber addition guidance is tempered by our sense of conservatism around the price increase we implemented January 1, 2012."

Investors should pay close attention to the subscriber metrics over the next few quarters. If churn is rising and conversions are falling, the growth in self pay subs -- and the revenue they generate -- will be constrained as Karmazin predicted.

Disclosure: I am long SIRI.

Additional disclosure: I also have covered calls against some of my Sirius position. I may open new covered calls or initiate (or close) a buy stock/sell option position in Sirius, discussed in a prior article, at any time. I have no positions or plans to trade any other stock mentioned in this article in the next 72 hours.