Sirius XM - Something For Nothing?

Mar.26.12 | About: Sirius XM (SIRI)

It was a bit disconcerting to see Stephen Faulkner's article Sirius XM: 100% Free followed quickly by Cameron Kaine's Sirius XM: There's No Such Thing As A Free Lunch. Have I suddenly become a Muse for two Seeking Alpha contributors that have recently been averaging more than an article per day on SiriusXM (NASDAQ:SIRI) - one short and one long? These articles took portions of recent articles of mine and went in entirely different directions.

First, I would like to thank both Faulkner and Kaine for the acknowledgement and the kind words. Second, I must point out that I consider both of them traders rather than investors, focusing on short term movements in the price based on charts. Third, I feel compelled to write this article to express my views in more detail on the topic. Fourth, when I began writing this article, it was mainly to focus on Faulkner's racing right past the most telling word in one of my quotes that he cited:

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

Fifth... maybe I should stop with the numbering for the moment. The issue that both contributors were focusing on was an idea floated by SiriusXM CEO Mel Karmazin at the Liberty Media Corporation (NASDAQ:LMCA) 2011 investor and analyst meeting on November 17, 2011. Karmazin spoke about the tens of millions of OEM installed Sirius and XM radios that will be idle in three to four years. He also said one way to monetize this asset would be to light up those radios and offer a few ad-supported stations for free. Keep in mind that Karmazin was speaking about OEM installed Sirius and XM radios - not an internet or a smartphone application, and that is all I intend to focus on.

Let me be clear. I am long SiriusXM and I am bullish on the longer term prospects for the company and the price of the shares. Based on my holdings, I am currently aligned with the position of Faulkner and on the opposite side of Kaine. I suspect that either of them is more likely to change their position than I am based on what the charts tell them to do. To be very clear, being bullish does not mean that I see a share price increase of another 20%-30% this year.

Faulkner wrote:

I hear much talk about possible saturation of paying subscribers, conversion rates, cancellations, churn, subscriber acquisition cost, and on and on and on.

I don't really worry myself with these things.

If he's reading charts and making decisions based on price movements, that makes sense. It also makes perfect sense if his "...long-term horizon is six to 12 months at the most." My time horizon is much longer and I am very much worried about subscribers, how many cancel and how much it costs to acquire them. It is crucial to the long term success of the Sirius business model. It is also why I am somewhat more in agreement with Kaine's position than I am with Faulkner's on the subject of offering a free service.

Kaine wrote:

One of the first things that I was taught while pursuing my MBA was that there is no such thing as a free lunch.

It was eerily similar to one of my classes and was going to be my choice for a title for this article "SiriusXM - TINSTAAFL." Unfortunately for me, Kaine got there first. The late Paul S. Nadler, a noted author and Professor at Rutgers Graduate School of Business, taught an introductory course on banking and the US economy. The first thing he wrote on the blackboard (yes, one of those things made of slate where a teacher would write with chalk) was "TINSTAAFL." And it was up there for every one of his classes. There Is No Such Thing As A Free Lunch. It was constantly driven home and is the most vivid memory I have of my two years Rutgers.

Anyone that has read just a few of my articles on Sirius knows that I disagree a lot with just about everyone. So many of the articles - mine included - focus on a single aspect of the company, and authors often make their point by ignoring the upside or downside to the case being presented. The articles of Faulkner and Kaine are no different, and I disagree with aspects of both.

First, Faulkner, because I like the alliteration, because it's alphabetical and because chronologically his article was written first. This model is NOT 100% FREE! It's not even close. Generally speaking, this would create an incremental, random, nationwide audience. What is not known are where these cars with inactive radios are located, how the owners will find out there are stations available for free listening, whether they will listen, etc. I have no idea what the total laundry list of costs would be, but here are a few things to consider:

  • Where will the advertising revenue come from? It has to be sold. And, to be sold, Sirius needs to tell the advertisers the size and demographics of the audience. There will be a cost to uncover this information. And there will be a further cost to market the value of the program to potential advertisers.
  • Much of radio advertising is local. Selling Dr. Bob's Lasik Surgery Drive Thru in New York City is meaningless to listeners in most of the country. Obviously selling ads for tires, auto insurance or car maintenance service centers with nationwide footprints are possibilities. And, it's not that selling national advertising is bad, it's just that it is a more limited market.
  • Would the ad-free model stymie Pandora (NYSE:P)? I would think there would be some effect, but if we are going to look at Pandora, we should also take a look at Pandora's largest cost - content acquisition, essentially the music royalty.
  • Yes, Stephen, there is a music royalty cost (with all due respect to Frank Church of the NY Sun) associated with playing free, ad-supported, music. Unlike Santa, it's real and it's expensive.
  • Some self-pay subscribers are almost certain to be lost. I won't pretend to know the number, but it is a safe bet that some will opt for free. There's a cost to the lost revenue.
  • How do you set up ad-supported stations? Where does the bandwidth come from to provide 10-15 ad-supported stations? Do you "steal" the bandwidth/stations from paying subscribers? How many current self-pay will quit if you take away their favorite station and replace it with an ad supported version? How many future potential customers won't bother to convert? What would be the cost in lost revenues from these former and future self-pay subscribers?
  • Devaluation of the brand. Maybe it's trivial, but right now SiriusXM is promotes itself as a provider of ad-free music to your car.

Some of these costs will be less difficult to determine than others, but they are all real. An ad-based service may or may not be profitable. And, while it is a free service to the listener in the sense that there is no payment of a monthly subscription fee, it is not free to the investors. There will be a cost. Or, more precisely, there will be lots of costs.

Now onto Kaine's article. By using information from my article, particularly the italicized paragraph near the beginning of this article, rather than listening to the original presentation by Karmazin, he jumped to an illogical conclusion. Kaine wrote:

And the last line of that comment is all that investors need to know why this is a bad idea. One of the qualities of any successful business is the ability to successfully analyze risk. As noted by Mel, the company will risk losing self-payers to its free offering - essentially killing the model that it has worked so hard to build.

The last line of my comment is not all investors need to know. "Mel" did not make a statement about the risk of losing subscribers. It was (and still is) my assessment. Kaine failed to question the lines that read:

the possibility of offering a free service where the stations would carry ads and the number of stations offered would be limited.

Karmazin was talking about offering a limited number of stations - specifically "10 or 15 radio stations that would be free" under an ad-supported program to address non-subscribing potential listeners. The discussion began with Karmazin stating that there were currently about 40 million vehicles on the road with satellite radios, growing to 75 million by 2015. Karmazin was not trying to turn the entire Sirius business model into ad-based terrestrial radio, just offering up an option to monetize an asset sitting idle in tens of millions of non-subscribers' vehicles.

Kaine wrote, "...this idea has been tossed around for years and it is not one that neither Sirius' management nor Liberty thinks makes any sense at all..." I am assuming that he meant Liberty and Sirius think the idea makes no sense, rather than the confusion caused by the double negative. I have no idea how he would know this. Is it the fact that Sirius hasn't done it yet? It could be that the timing is not yet right.

Kaine writes, "For Sirius to be successful well into the future, it needs to not only forget about "free,"... " I intend to keep a much more open mind.

Crunching the Numbers
Did you really think that there was going to be a dollars and cents answer to this question? The issues surrounding the offering of a free service on a limited number of stations are, to say the least, complicated. How does an outsider determine the demographics of the potential audience, track the number of users that will tune in to a free service, which stations and which programs will be listened to, the potential advertising rates, the number of ads per hour, the cost of selling advertising spots, etc.

And this doesn't even begin to address potential self-pay subscriber losses. Or the music royalty. Or the possibility that some of the self-pay subscribers will keep their subscription, but occasionally "lower" themselves to listen to the ad-supported stations because they carry some of the music they want to hear.

It's way too complicated for me to take a stab at, but it would make for a great case study in a marketing and finance course. I would hope that Sirius management carefully assesses all the risks and opportunities associated with such an offering and makes a decision based on whether it will increase the bottom line over the long term.

Summary
In my view, Faulkner is clearly incorrect in this alternative being "100% Free". In my view, Kaine has clearly gone too far in stating the company must "forget about free" to be successful. As I noted in the paragraph referenced by both authors, I considered this "One intriguing idea" and "one that also has the risk that it could cost Sirius some of its current self-pay subscribers." Faulkner, Kaine, Seeking Alpha readers and I can choose to interpret the idea floated by Karmazin as being positive or negative, but to understand all the nuances, each should do their own due diligence and check out the source material. (To save time, one can jump to slide 57 of the very long presentation.)

And if someone is willing to model this entire scenario into a detailed marketing plan, including the spreadsheets showing the risk and reward, they should send it to Karmazin. Oh, and please copy Messrs. Faulkner, Kaine and Crunch.

Disclosure: I am long SIRI.

Additional disclosure: I have $3 January 2013 covered calls against most of my Sirius position, as well as some $2 and $2.50 January 2013 covered calls. 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 any plans to open positions in the next 72 hours, in any of the other companies mentioned in this article