Many SiriusXM (SIRI) bulls are disappointed that the price of Sirius did not take off after the first quarter earnings were released and the conference call took place. After all, if CEO Mel Karmazin tells analysts and investors "Our first quarter results show the power of our high-margin model that is producing exceptional subscriber and cash flow growth for our investors," and when CFO David Frear adds "This was a great quarter for SiriusXM on all fronts," shouldn't we all expect that the shares should also trade at record highs? Clearly the market's reaction, which drove the share prices lower, indicated that as good as the results were, even more was expected.
There were some results in the first quarter that were, to a degree, unexpected. Churn came in at 1.9%, well below the 2.1% guidance. And we learned that the company has retired $130 million of high interest debt. We also found out that there are now 5,000 dealers participating in the used car program, a program that will contribute about one million gross subscriber additions in 2012. These are all positives.
These positives might have had a more significant impact if investors had not been trained to expect Karmazin to under-promise and over-deliver. Or, if these same investors hadn't heard Karmazin tell Cramer on Mad Money that the impact of the price increase on cancellations (i.e. churn) was "very modest" in February. More importantly, each of these silver linings may have a dark cloud.
Reflecting on the share price decline, Stephen Faulkner wrote "...I would ask, "What has changed for the worse with Sirius XM?" "
I, on the other hand, would ask "What has changed for the better at Sirius?" If there are expectations of a beat and increased guidance based on Karmazin's history of conservative guidance and telegraphed by his comments to Cramer, then the conference call was about as expected. And that could present a problem for the near term price of the shares.
I think it's great that Sirius has purchased $130 million of its high interest debt this year. The company will generate millions of dollars in increased income through savings on the interest expense. On the other hand, others that have been hoping for a share buyback may have been disappointed that the company is proceeding on a path to reduce leverage rather than repurchase shares. Still others might have been hoping that the company would use its cash to accelerate its growth rate through acquisitions, marketing programs or engineering and development programs.
Lowering the debt is great from my perspective, but it may be a negative indicator for others. Using funds in this manner grows profitability, but does nothing to grow the business. A great deal of growth is expected from a company when its stock trades at a high P/E multiple (even after the recent share price weakness) - Yahoo Finance shows a 2013 P/E of 21.6x and CNBC shows a 12 month forward P/E of 30.9x.
In addition, Liberty Media (LMCA) holds significant negative controls over Sirius. From the current 10Q:
We have historically financed our operations through the sale of debt and equity securities. The Certificate of Designations for our Series B-1 Preferred Stock provides that, so long as Liberty Media beneficially owns at least half of its initial equity investment, Liberty Media's consent is required for certain actions, including the grant or issuance of our equity securities and the incurrence of debt (other than, in general, debt incurred to refinance existing debt) in amounts greater than $10,000 [this is $10 million - the 10Q reports the financial data in thousands] in any calendar year.
This paragraph indicates that once Sirius retires debt - which Sirius has done this year - it must get permission from Liberty to incur new debt. When a minority shareholder has the ability to limit the company's flexibility to incur new debt, it is difficult to spin it as a positive.
Churn coming in at 1.9% was surprisingly strong considering that a price increase was implemented. The rate also helped to drive net subscriber additions. Investors really need to question why the number was lower than expectations. Was it because subscribers don't care about a $1.54/month increase? Was it something else?
The answers can be found in the 10Q and on the conference call. First, many of the Sirius subscribers are on long term plans and have not yet come up for renewal. Karmazin stated:
While it's early and we still have much work to do, we have now billed 35% of the self-pay subscriber base at the new higher rate, and the reaction to the price increase has clearly exceeded our expectations.
Still, 35% is a significant sample size. In a description of the Average Revenue Per User - or ARPU - was the following:
The increase was driven primarily by the increase in certain of our subscription rates beginning in January 2012, an increase in sales of premium services, including Premier packages, data services and streaming, partially offset by an increase in subscriber retention programs and in the number of subscribers on promotional plans...
Retention discounts, which help to reduce churn, and promotional plans can be profitable and useful over the short term. They generate revenue that may otherwise have been lost. However, when the company must increase the use of retention programs and the number of subscribers on promotional plans (think six months for $25), it can be viewed as an indication that it is finding it increasingly difficult to maintain subscriber growth rates.
Used Car Programs And Net Additions
It was enlightening to find out that there are now 5000 dealers participating in the used car free trial program. Previously, various company officials have indicated the conversion rates for free trails on used cars are lower than the 45% conversion rate for new cars - a percentage rate in the mid to high 30's. It was also surprising to learn that there would be about one million Gross Subscriber Additions from the used car programs.
All of this sounds outstanding. There should be more than 300,000 Self Pay Subscribers from the used car program based on the conversion rate and projected Gross Additions.
So, with new vehicle sales running well ahead of the first quarter of 2011, churn rates at only 1.9% and a robust used car program, why are the Net Additions only being guided to 1.5 million. Isn't this just more of Karmazin being conservative? On the call he said:
...this strong first quarter performance has made us comfortable in raising our full year net addition guidance from 1.3 million to 1.5 million. ... And yes, we continue to be conservative, but are more optimistic than we were 3 months ago.
If used cars are this strong, and new vehicle sales are strong, shouldn't guidance be raised much more? Even with Karmazin's history of being conservative, the low number can certainly be a cause for investors to be concerned.
Fair Value of the Shares
Are the shares priced correctly? Many bulls writing articles and comments on Seeking Alpha seem to think Friday's closing price of $2.16 represents a great buying opportunity. They will point to cash and Free Cash Flow (FCF) or the unrecognized value of the spectrum or the NOLs or the monopoly. Others will claim there is market manipulation and short sellers conspiring to keep the share price down.
I look at the current and projected FCF per diluted share and see a share price I consider reasonable. It's a price that will continue to grow at a rate faster than the general market. It's also a price that is held in check by the uncertainty about what Liberty Media will do with its significant stake in the company.
Liberty continues to exercises significant negative controls over Sirius. These controls extend beyond the debt control noted above. From the 10Q: "Liberty Media Corporation has significant influence over our business and affairs and its interest may differ from ours."
When management has trained investors to look at company guidance as conservative, exceeding and even increasing guidance that guidance, creates much less excitement. When management uses superlatives to describe its performance and doesn't raise revenue, EBITDA or FCF despite raising net adds, isn't that a legitimate cause for concern? And if investors bid up the price prior to the CC expecting increases in revenue, EBITDA and FCF, doesn't that also put pressure on the price?
The market and individual stocks hate uncertainty. They move on news flows, technical factors, emotions, sentiment, confidence, momentum and a whole host of other factors. Individual stocks move largely on future expectations and as these expectations change over time, so does the price. During the conference call there was an incredible amount of focus on historical financial metrics, but little that stirred up excitement going forward. That's fine for those looking for longer term, stable growth (and I am), but I think most investors have much greater short term expectations.
And based on the reaction of the share price this week, they were disappointed.
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 hold no positions nor do I currently plan to open a position in Liberty Media.