With less than 2 weeks to go before the SiriusXM Radio (SIRI) first quarter earnings release and conference call, it's a good time to speculate about whether or not the company will surprise investors. A number of events that have taken place so far this year have increased the uncertainty surrounding the stock. These include:
- the increase in the basic monthly subscription rate from $12.95 to $14.49 effective January 1
- releasing 2012 subscriber guidance of 1.3 million net adds, a decrease of 0.4 million from 2011's 1.7 million
- the expiration of the last of the Standstill Restrictions enabling Liberty Media (LMCA) to acquire more than 49.9% of Sirius without making a tender offer for all the outstanding shares and/or approval from the independent outside directors effective March 6
- the Liberty Media application to the FCC for de facto control of the Sirius licenses, a Sirius petition to deny Liberty's application, the Liberty response to Sirius...
- Sirius filing antitrust claims against Sound Exchange
- strong vehicle sales in the first quarter
- a Sirius court victory with the dismissal of a lawsuit brought by Howard Stern and his management company against Sirius
- the first OEM committing to put a 2.0 radio in their 2013 vehicles
So, what does Sirius need to report in order to move the share price higher? The easy answer is that Sirius needs to report numbers that beat investor expectations. Unfortunately, it is not at all clear what investor expectations are. Sirius CEO Mel Karmazin has stated that he prefers to be conservative when issuing guidance about the company's performance. This was emphasized when the company issued subscriber guidance of 1.3 million net additional subscribers for 2012.
Karmazin discussed the merits of being conservative with subscriber projections when questioned by Barton Crockett of Lazard Capital on the year end conference call:
...First of all, I am saying that we are being conservative. There is no information that we have about our business. Our most recent quarter, our fourth quarter showed the best fourth quarter in our history since the merger as far as net adds are concerned. So there's nothing that we are seeing impacting us. We're not seeing any new competition that's impacting us. We're not seeing any dissatisfaction of our service. What we're doing is we are putting in a price increase. We made that decision to do and we really don't know exactly what the impact is going to be on subscribers, mainly because we have very limited experience at the company in putting in a price increase. We compete with free. So in an ideal world, we would have lower cost per service, but that doesn't generate us as much revenue and EBITDA and free cash flow as we're looking for. So I mean, we're starting out conservative. We're not seeing anything impacting our January churn that is alarming to us at all. I think it's prudent to be conservative and that's the basis of the 1.3 million.
A couple of weeks later CFO David Frear used similar arguments at a Morgan Stanley conference, stressing that the 1.3 million was conservative. Frear also discussed why the impact of the price increase would be gradual in terms of an increase in churn. More than half the Sirius subscribers are on annual, or longer, plans and would only gradually be impacted by the price increase in 2012. In addition, when asked about ARPU and retention discounting, he said:
We don't intend to lose a single subscriber... We will use all the tools at our disposal to keep subscribers. It's hard to get them.
Frear also indicated that he was hopeful that Sirius could keep subscribers without discounting.
The real issue with subscribers will be cancellations, whether from the price increase, or for any of the other usual reasons that subscribers cancelled before Sirius ever implemented a price increase. If Sirius experiences a 2.0% churn rate (less than the company guidance of 2.1%), the company needs to replace nearly 1.1 million deactivated self-pay subscribers during the first quarter. These 1.1 million subscribers are in addition to any paid promotional subscribers whose trials end and choose not to convert to self-pay subscribers.
With neither Frear nor Karmazin indicating there was weakness in the first six to eight weeks of 2012, a gradual impact from the price increase and strong vehicle sales in the first quarter, the logical conclusion is that Sirius should have a strong first quarter in terms of subscriber growth. Also supporting this "logical" conclusion are the large number of trials. We know that there were 0.5 million more paid promotional trials at year end 2011 compared to year end 2010. In addition to these paid trials, there were 1.4 million unpaid trials at year end 2011, up from 0.8 million at year end 2010. These unpaid trials are not included in subscriber data until they convert, but they will provide additional future self-pay subscribers to the total.
The real issue is that with all the caveats by Sirius executives about how the subscriber forecast was conservative, investors and analysts are now expecting the company to exceed guidance and post strong numbers. The question investors should consider is: How large will subscriber net adds need to be to satisfy investors and analysts?
Sirius has projected revenue to grow 10% in 2012 to $3.3 billion. It is a very conservative growth rate, especially when one considers that the company exited 2011 at an annualized run rate in excess of $3.1 billion. Will the subscription price increase have much of an impact on ARPU? Probably not in Q1. As noted, many of the subs are on multi-year agreements and the price increases will be implemented on the anniversary date. The impact will be increasing throughout 2012 and into 2013. It is also likely to be mitigated by retention discounting to ensure the company exceeds subscriber net add guidance for 2012.
Other First Quarter Events
Most of the other Q1 events - Stern lawsuit, auto sales, Sound Exchange suit - have, to an extent, been priced into the current Sirius share price by the market. The issues around Liberty Media's objectives with its FCC filing and intentions with respect to the expiration of the standstill restrictions are unlikely to be addressed by Sirius. For that matter, they may not be discussed much by Liberty at its own conference call the following week.
Sirius should show strong subscriber numbers in the first quarter. The only questions are whether it will come from used car initiatives and strong auto sales or due to heavier than expected retention discounting. And, even if the numbers show strength, will it be sufficient to satisfy investors and analysts who are already looking for numbers that beat the company's conservative guidance?
I expect to see subscribers on a growth path to exceed 1.3 million net adds in 2012. I will also be disappointed if the numbers don't support an annualized figure at least as high as 2011. The company will find it much easier to show excellent progress on exceeding revenue projections, but as with the subscriber guidance, will it be enough?
One final note. Q1 has been an erratic quarter for adding subscribers. For the past three years the net adds have been -404,422 in 2009, 171,441 in 2010 and 373,064 in 2011. Not exactly the type of figures on which to base an annual prediction.
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 plans to trade Liberty in the next 72 hours.