How is it that there could possibly be hidden gems in a company like Sirius XM (SIRI) that is so widely followed and studied. In actuality these gems are not really hidden, but rather some things that we do not typically look at despite the fact that they are there in front of us. These are things I know and watch develop. Now I am sharing them with you.
In this day and age we are almost programmed to look at certain metrics the way they are presented without question. Quarter after quarter we see the company talk about subscribers, Self Pay Churn, Adjusted EBITDA, Revenue, Free Cash Flow, Subscriber Acquisition costs, Penetration Rate, Conversion Rate and a host of other things. It has almost gotten to the point that a long term investor can write the script for a quarterly call.
I am not saying the these metrics should not be followed. They most certainly should. However, there is a lot of information that the company gives out and sometimes its pays to dig a bit deeper in the numbers to help gain an idea of where the company is headed.
There are three hidden gems in the Sirius XM quarterly report that most of the street will not see, but a savvy investor will be aware of. Of course, this story has been building for quite some time now, but until it starts to become real, the profits from knowing these gems would be difficult to realize. You see, the value in these gems comes when the light finally dawns on the street. That will happen over the next year.
GEM #1 - Net Operating Losses (NOLs)
These were the terrible things that long term investors had to endure quarter after quarter and year after year with satellite radio. I can remember vast discussion about when one of the two satellite radio providers would finally reach "cash flow break even", which was seen as a critical juncture.
Over the years Sirius XM built up almost $8 billion in NOLs. Now all of those years of frustration will bear some fruit. Sirius XM gets to use these losses to offset taxes. Essentially the company can operate tax free for many quarters to come. That translates into better earnings which is good for the stock.
In theory, just being able to use the NOLs is a victory. What we have here is something more. In Q2 of 2012 Sirius XM recognized about $3 billion in NOLs. This changed the look of its books tremendously. Instead of reporting an EPS of 2 cents per share, the company reported 48 cents!.
Here is why these NOLs are going to be so special to long term investors. The street tends to ignore them. They are usually backed out of the equation. Thus, as the street is expecting an EPS of 2 cents and the company delivers 48 cents, guess what happens! That's right, everyone says, "WOW....I better get in that".
With Sirius XM you often here of valuing the company based on the EV/EBITDA multiple. This is a valuation method typically used to gauge media companies and is very well accepted by the street. Essentially it is the Enterprise Value divided by the EBITDA. Enterprise value is established by the market cap + debt - cash. The higher the multiple, the more of a premium an equity is said to be trading at. In many ways the NOLs are sort of like cash, so the sudden inclusion of $3 billion actually serves to lower the EV/EBITDA multiple if the NOLs are included. See the models below:
As you can see, when Sirius XM was trading at $2.40 last Friday it was trading at a multiple of over 19 if we exclude the NOLs. When SIRI gets above a multiple of 20 it typically sells off. However, if we consider the very real impact of the NOLs, it was only at a multiple of just above 16. The beauty in this secret is that the NOLs are very real for several quarters to come! While the street ignores them and looks for a sell-off, a savvy investor will know exactly why there is still gas in the tank to continue a run.
Why does the street ignore the NOLs? Typically it is because they are not representative of how the company would typically perform if they did not exist. Further, they are removed for comparison purposes with other media company's. The comparisons are not necessarily done to propose an investment in another company, but simply to see where Sirius XM sits relative to other companies.
The chart on the right shows Sirius XM with a $3,00 price target with some new assumptions for 2013 including debt, outstanding shares, and EBITDA.
Hidden Gem #2 ARPU vs ACPU
I can already see some investors scratching their heads. We all know that ARPU stands for Average Revenue Per User. So what is ACPU? The company never speaks of such a metric! ACPU is Average Cost Per User. It is a metric that can be derived in the same manner as ARPU but instead of looking at revenue it looks at costs.
I often encourage and challenge investors to look beyond the numbers and company line. The company is always going to point out the positive side of things. A savvy investor digs deeper to identify the potential risks or to unearth some hidden gems within the numbers. I created ACPU out of digging through numbers.
We all hear that revenues are rising and that costs are being cut, but rarely do we sit down and determine what that really means in a simple and concise manner. Instead we wait for another quarterly report that will spell out an EPS that either meets expectations, exceeds them, or misses. What if you can work a simple way to determine the path of success ahead of time?
With Sirius XM the ARPU has been trending up (good) and the ACPU has been trending down (doubly good). This results in the potential bottom line increasing (triply good). See the chart below:
While ARPU is showing modest increases of 1.5% to 2%, the cost side, which rarely gets attention is showing impressive improvements of 4.2%! Better yet, the bottom line potential is showing an amazing improvement of 26.2%! While the rest of the street celebrates single digit improvements, you can know that the actual story is much better.
Do you want to be even more impressed? Consider what happens when Sirius XM refinances some $400 million in debt from 13% down to 5.25%! The cost of doing business just got cheaper, and the potential to the bottom line will improve even further.
There is a bit of caution here. Remember, the street is looking for the price increase to drive ARPU up markedly. This is where management setting the proper expectations becomes paramount.
The Third Hidden Gem - Used Cars
While the street celebrates the recovery of the auto sector to the tune of a 10% improvement each year, the savvy investor is looking to the new subscriber bucket that Sirius XM has rolled out. The used car channel. Some 6,000 dealers out of about 20,000 are already participating in giving consumers a three month trial.
These trials enable Sirius XM to market to the consumer and find a second life for a factory installed radio. With 4 used cars selling for every one new car, it is a natural market to go after. As if that is not great enough, the number of satellite radio equipped used cars is expected to grow by a rate even greater than the new car markets 10%!
It is anticipated that the satellite radio equipped cars will go from 45 million in 2012 to 55 million in 2013 (a 22.5% increase), and then another 10 million each year after that for quite some time. With each passing quarter the used car bucket carries more potential subscribers, more value, and more potential. This will be a significant source of growth moving forward!
Simply stated there are reasons to be excited about Sirius XM in 2012. Some of those reasons are quite compelling, and as yet not realized by the street. whenever you know something that the street does not you are putting yourself in a superior position.
Disclosure: I am long SIRI.