Sirius XM Undervalued: Could Rally 25% On Strong Q2 And Momentum

Aug.17.12 | About: Sirius XM (SIRI)

Sirius XM Radio Inc. (NASDAQ:SIRI) declared strong financial results for the second quarter of 2012 with record high revenue, EBITDA, free cash flow, and net subscriber addition. As per management, its growth momentum will further expand in the rest of 2012. Management has raised financial outlook for the second half of 2012. (Read more)

SIRI Net Income Chart
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Shares of the company have been rising steadily and gathered enough momentum after the Q2 earnings. In this article, we'll explain why we think the shares could touch $3.25 in the short-term. At first, we'll make an attempt to discover the present discounted "fair value" of the stock based on fundamental analysis. Next we'll focus on analyzing how much upside is left for the stock in the near-term based on technical analysis.

Discounted Cash Flow Analysis

Taking the forecast cash flows and discounting them back to a single present value using the discount rate gives an Enterprise Value. The Enterprise Value is the value of the whole business (debt and equity). To calculate the value of equity, Net Debt is removed from Enterprise Value. Net Debt is long-term borrowing less cash. Enterprise Value less Net Debt is the value of equity that can then be divided by number of shares outstanding to arrive at the intrinsic value of a single share.

At an early or start-up stage of business, there is considerable uncertainty surrounding the future of expected revenues. High short-term growth rates and the uncertainty associated with an early stage venture can seriously limit the validity of any valuation model. Keeping that in mind we've used very conservative inputs in our DCF model for Sirius XM.

Key inputs into the DCF valuation:

  • CAGR EPS Growth (2012-2016): 10%
  • WACC (Weighted Average Cost of Capital): 17%
  • Terminal Growth: 0%

We've arrived at an intrinsic valuation of $4.26 per share of Sirius XM. Although the uncertainty of future cash flows is incorporated into the higher than average 17% discount (OTC:WACC), there is a limit to the ability of the discount rate to reflect high levels of uncertainty and produce a meaningful estimate of value. We'll therefore incorporate the results of Relative Valuation Analysis into the intrinsic value we've arrived at using DCF model.

Relative Valuation Analysis

Relative valuation versus industry peers is widely used in conjunction with DCF methods while providing estimates of fair value.

PE Ratio

  • Sirius XM: 4.887
  • Liberty Media (NASDAQ:LMCA): 21.96
  • Entercom Communications (NYSE:ETM): 17.35

SIRI PE Ratio Chart
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Price / Sales Ratio

  • Sirius XM: 3.087
  • Liberty Media: 4.503
  • Pandora Media (NYSE:P): 5.268
  • Entercom Communications: 0.6508

SIRI Price / Sales Ratio Chart
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If we find the relative valuation of the company versus its peers is attractive, we attach a 10% premium to the intrinsic value based on the DCF model. If it appears the relative valuation is unattractive, we attach a 10% discount. From the charts presented above, it's quite clear that Sirius is attractive in terms of P/E and Price to Sales. So we'll attach a 10% premium to the intrinsic value of $4.26 and we get $4.69.

Net Tangible Assets Analysis

As a base valuation, professional analysts will look at the balance sheet Net Tangible Assets figure. This is total assets less any intangible items (goodwill etc.) less total liabilities. The chart above shows the Net Tangible Asset position for Sirius XM has improved remarkably in the second quarter. The amount of intangible items in the balance sheet is negligible. Further, the Debt to Assets ratio has declined significantly over the last two quarters.

For a small cap growth company, we don't attach any premium for a strong balance sheet but for a weak balance sheet we attach a 5% discount to the value we deduce using the DCF Model and Relative Valuation Analysis. So finally our fair value stands at $4.69 per share for Sirius XM.

Technical Analysis: Momentum Building Up

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Yesterday, the stock created a high of $2.60 and closed almost at that high point. In April, a high near $2.40 was made. The RSI and MACD indicate the stock is overbought for the absolute short-term i.e. for a day or two-day perspective.

The 20-day SMA line and the 50-day SMA line have crossed the 200-day SMA line from below, which indicates the outlook for the stock is extremely bullish for the near-term. We expect the stock will move up again from next week. Analyzing the momentum that's building up, we expect a 30% to 35% higher high from the last high to be made in this new up-move, this is quite natural for a stock under $3. That will take the stock near $3.25. Any consolidation today or early next week would be a golden opportunity to enter this counter.

Disclosure: I am long SIRI.