In April of this year, Forbes ran an article on CEO pay. It singled out Sirius XM Radio (SIRI) Chief Executive Officer (CEO) Mel Karmazin as the "Worst CEO for the buck." The process was said to be objective. It screened the country's largest companies to find CEOs of publicly traded companies with 6 years of tenure. These executives were ranked based on stock performance relative to compensation.
Forbes said that Mr. Karmazin earned more than $37 million at Sirius since he became CEO in November 2004. Forbes expects that he will earn an additional $125 million from the planned exercise of its stock options. In fact, it has sold more than 17 million shares at the price of $1.97 to $1.98. Karmazin still has $49 million shares.
In his defense, Mr. Karmazin said that he believes he is one of the most underpaid executives in the history of executive payment. He highlighted the growth in subscriber counts. Sirius had 660,000 subscribers when he assumed the role of CEO and is now around 22 million. He also added that the operating cash flow and free cash flow has improved from the increased in revenues. From 2004 to 2011, revenues have grown from $67 million to $3.015 billion. Operating cash flow has also increased from negative 334 million to $544 million. However, the stock price has fallen from around $9 in 2004 to below $2 at current levels.
The Best Way to Measure Management is Capital Allocation
Warren Buffett said that the best way to assess management performance is how it allocates the company's resources. It should either reinvest or payout the company's funds to increase shareholder's wealth. I believe the best measure is the incremental cash flow from the amount of cash it has invested.
Since 2009, Sirius XM has grown its free cash flow from $185 million to $406 million. Over the last 5 years, accumulated free cash flow reached $1.18 billion, with capital expenditures of $893 million. This means that for every dollar the company has invested, it returned $0.30. During the same period, it repaid a total of $738 million of debt. The result shows that the company's financial position has improved. Debt to equity has declined significantly from more than 50 times to 7.5 times. Despite the decline in debt ratios, this is still high by any standards. The company has not paid dividends. I believe that it will not pay dividends in the near term as it focuses on improving its financial position.
The key driver for the company has been its increasing average revenue per subscriber, notwithstanding the significant increase in subscriber counts. In 2008, average revenue per user reached $84. For the next 5 years, average revenue per user increased to $119. Going forward, I expect this to be higher as it plans to increase rates on multi-subscription packages and new package bundling.
Sirius XM has also improved its operating margins to 22% in 2011, higher than the 9.2% operating margins in 2008. Its operating margins have improved from lower sales and administrative expenses as it implemented cost effective measures. These operating margins appear better relative to its peers. Saga Communications SGA), for example, has operating margins of 19%, CBS (CBS) has operating margins of 17%, Radio One (ROIAK) has operating margins of 4%, while Salem Communications (SALM) boasts operating margins of 18%.
This also translates to strong return on equity of 30% for Sirius. Competitors have lower return on equity. Saga Communications carries a return on equity of 14%, Radio One with return on equity of 1.45% and Salem has return on equity of 3.18%. I expect the company to maintain high return on equity as it will attain higher profitability in the future.
From these figures, it seems that its CEO should be credited in improving its financial position. A few years ago, the company was battling for survival as it faced possible bankruptcy.
Liberty Interactive (LINTA), formerly Liberty Media, extended $530 million in 2009 to help Sirius XM pay off its debt and avoid bankruptcy This also gives Liberty a 40% stake in the company, and made it the company's largest single shareholder.
Recently, the provision blocking Liberty to raise its stake has expired. Liberty has repeatedly shown interest to acquiring a majority control of the company. Sirius has asked the FCC to deny or dismiss its application to take a "de facto" control of the company, through earth station licenses and takeover of other assets. Liberty is planning to take control of the company's core business assets to complement its own existing assets.
The Decline in Stock Price is Due to Lofty Valuations
The Forbes rating to assess Mr. Karmazin based on stock price performance is flawed. It is true that strong fundamentals will be reflected in the stock price. In the case of Sirius, Mr. Karmazin joined the company when the stock price was overvalued. This means that the stock price has moved ahead of its fundamentals. Investors have high expectations of the stock.
At present, the stock trades at 27 times earnings. This is higher than the industry's average of 16 times earnings. However, it currently trades at the lower end of its 5-year multiple of 27 times. Meanwhile, most of its peers are trading lower. Saga Communications is valued at 11.50 times earnings, while Liberty trades at 18 times earnings. On the other hand, Salem Communications is valued at 30 times earnings.
It seems that Sirius XM's fundamentals are catching up. The bad news is that shareholders who have bought at higher prices will have to wait a little longer before they can experience capital gains. If you don't already have a position in Sirius XM, I think now is a great time to buy.