Sirius XM: Every New Subscriber Adds Increased Profit

Jul.13.12 | About: Sirius XM (SIRI)

When you consider a business like Sirius XM (SIRI), it's important to understand how it derives its income. That said, with Sirius XM its income is quite simple. The vast majority is received through subscription revenues.

This is something every investor should understand, but something which I feel is often overlooked or neglected. While volume is important to nearly every business, in a subscription based business like Sirius XM there is a pivot point where expenses are met, and each and every subscriber added after this point increases the bottom line to a greater extent than it increases costs.

Consider the following graph. You'll notice actual values have been omitted as they are unimportant to illustrate the main point. Costs and loss are in red, and income and profit are in green.

Click to enlarge

You should notice that costs increase with subscribers at a lower rate than income, and thus profit, increases with subscribers. Why is this? Because each and every new radio that is activated simply costs Sirius XM a percentage in royalties, and a miniscule amount of human resources for things such as billing and customer service. No new channels are needed, no new satellites need to be launched, and no new product needs to be developed to service that subscriber. The reality is that the big expense items are already paid for and in place, and thus income from every new subscriber does not go towards paying for these expenses.

Since Sirius XM has passed the break even point and currently produces a profit, it is important for investors to understand that an increase of over 1,000,000 subscribers already this year is a "big deal." Sirius XM absolutely does not have to double subscribers to double profit currently.

It's quite amusing to hear the bearish arguments which state Sirius XM may see subscriber growth plateau. Of course it will, eventually, but Sirius XM does not need to maintain the current rate of growth in order to increase income and profit. It could actually add fewer subscribers than the year before, and still increase income and profit. When you consider that the rate of addition has actually accelerated, and appears to be on a fast track towards a solid beat of last year's additions, this is more bullish than it may appear on the surface.

As Sirius XM moves forward and continues to add subscribers at such a heavy pace, income, and profit, will increase much faster than costs and expenses. Watch that subscriber number. Understand how important it is that it is currently on track to possibly reach 2 million additions this year. While the current goings on surrounding Liberty Media (LMCA) may be a weight on the share price, consider that things have never looked better for Sirius XM. 2012 should round out as a banner year for the company.

Disclosure: I am long SIRI.

Additional disclosure: I may initiate a long position in LMCA at any time.