If you have been invested in Sirius XM Radio Inc. (SIRI) for any length of time, you probably understand the dynamics of expectation levels. For quite some time, Sirius XM was faced with lofty analyst expectations, and even when reporting a decent quarter, it looked like a miss. That trend has been somewhat corrected in 2012, but once again, we are seeing analysts project something lofty on Sirius XM that it may not be able to achieve given a realistic model. Worse yet, many analyst models have not been updated in quite some time regarding the quarter-to-quarter EPS.
Sirius XM investors could, at a quick glance, come to the conclusion that the company is expected to report 3 cents in Earnings Per Share (EPS) when, given recent news about debt refinancing and payoffs, becomes a substantial challenge. More likely than not, the company will report 2 cents (removing the NOL impact).
To start with, even the most bullish analyst, John Tinker of Maxim Group, calls for Sirius XM to report Q3 earnings at 2 cents. He models revenue at $875 million and the cost side at $715 million. His conclusion is that Sirius XM will report an EPS of 2 cents a share on a share count of 6,538,000,000. The actual EPS according to his model is $0.0245. He rounds down, as is appropriate. It should be noted that the Tinker model does not consider any of the costs associated with the debt refinancing activities that will happen in Q2. It should also be noted that the 293,000,000 shares associated with the 7% notes are not part of his calculations. This often happens because it is a one-time cost and not indicative of the overall business model.
The point of this piece is to get readers to think ahead and think for themselves. The debt refinancing and paydown is a good thing overall, but it will carry a negative impact in Q3. Because most analysts have not accounted for this, an expectation level is being established that simply does not exist in any realistic model.
What will transpire in Q3 is that the company will outline an EPS on an adjusted basis. In other words, it will remove the one-time costs associated with the debt in order to paint a more realistic picture. However, the challenge with this is getting that information out to the Street in a meaningful manner. As of right now, with sites like Yahoo calling out for 3 cents, it will appear that the company will miss.
Building a model for EPS is actually quite simple and can be accomplished in less than half an hour. If we use Tinker's share count of 6.538 billion shares we can model some reasonable assumptions and arrive at an EPS. I would highly recommend that investors use a share count of 6.799 billion though because of the 7% notes, and the extreme likelihood that the stock will close above $1.88 at the end of the quarter. Before going into a model though, lets look at what it would take to arrive at a 3 cent EPS.
It would take NET earnings of $164 million using the Tinker share count and $170 million using the share count we will likely see in Q3. Now let's build a model and see what we arrive at.
Subscriber revenue - I am modeling $760,000,000 for Q3 of 2012. In Q2, the company reported subscriber revenue of $730,285,000. This would imply that revenue jumped by about $30,000,000.
Advertising Revenue - I am modeling $23,072,000, which matches the 11% increase we saw from Q1 to Q2. My number in this model might be slightly aggressive, but I am intending this to be aggressive, so that readers can understand why expectations can be quite lofty.
Equipment Revenue - I am modeling equipment revenue at $16,500,000. This is essentially in line with previous quarters.
Other Revenue - I am carrying $71,100,000. This shows modest growth in the line item that encompasses the music royalty fee and income from the Canadian operation. A 1.5% increase is actually aggressive.
Total Revenue - I arrive at total revenue of $870,672,000.
Revenue Share and Royalties - I am carrying $138,800,000. This is about a 2.5% increase in this line, driven by subscriber additions. The increase from Q1 to Q2 was also about 2.5%.
Programming and Content - I am carrying $64,000,000 in programming and content. This represents a small savings from the last quarter.
Customer Service and Billing - I am carrying $71,100,000 for this category. It represents just over a 3.5% increase from the last quarter. That is a similar increase to the delta between Q1 and Q2.
Satellite and Transmission - I am carrying $16,000,000, which represents a savings over last quarter.
Cost of Equipment - I am carrying $7,100,000 in this category, which represents a savings from the last quarter. It should be noted that this line item actually increased from Q1 to Q2, so I am modeling aggressively.
SAC - I am carrying $135,000,000 in this category. This represents the cost of $54 each for 2.5 million gross subscriber additions.
Sales & Marketing - I am carrying $55,000,000 here, a modest savings in line with what the company has been doing in 2012.
Engineering and Development - I am carrying what I call a conservative $8,000,000 in this line item. In Q1, this line was over $12 million. In Q2, it was over $6 million.
Administrative and General - The company spent $65.664 million in Q2 and just over $59 million in Q1. If I mimicked the 10% increase we have seen so far this year, I would carry $71.5 million. Being aggressive, I will carry $68,500,000
Depreciation an Amortization - I carry $67,000,000
Total Operating Expenses - $630,500,000
Income From Operations - $240,172,000
Interest Expense Net ($70,000,000)
Loss on extinguishment of debt ($000,000,000) - There will be charges.
Interest on Investment income ($1,200,000)
Total Other Expenses ($101,200,000)
Income Before Taxes - $168,972,000
EPS fully diluted - 3 cents per share ($0.026) using the Tinker number, but 2 cents ($0.024) using what will be the share count reported on the call.
As you can see, even with this very aggressive model, the EPS barely gets to 3 cents, only does so if you apply the improper share count, and in addition I have left out the very real costs associated with retiring debt. In Q2, debt extinguishment costs were $15 million. In Q3, they will actually be more substantial.
If you say that extiguishment will only carry an impact of $30,000,000, the EPS would be 2 cents ($0.021) with the Tinker share count and 2 cents ($0.020) with the real share count.
If you think the extinguishment of debt will cost $60 million, the EPS will be 2 cents ($0.0166) with the Tinker count and 2 cents ($0.0160) using the count that will be reported.
If you think the extinguishment of debt will cost $90 million, then you are looking at a real potential of an EPS at 1 cent per share.
In my opinion, the only way Sirius XM can possibly report an EPS of 3 cents is if you are aggressive on revenue and aggressive on the cost side as well. Even at that you only arrive at 3 cents by rounding and applying an artificially low share count! Herein is the problem and quandary. Expectations are being set at 3 cents, but arriving there only happens by the skin of Sirius XM's teeth and with aggressive modeling. We now know there will be costs in the quarter that will take Sirius XM away from any chance of reporting a clean 3 cent quarter. What we now have is a classic case of expectation levels being set to high, compounded with new one-time costs that should lower expectations further.
The finalized costs associated with the debt issues will be able to be better calculated when the repayment happens on September 1 and September 20. You can begin to build a model now by looking at the debt issue and calculating the costs to retire it by prepaid interest, bank fees, premiums, etc.
What I encourage here is deeper thought that looks at both the revenue and cost side of the equation. If your opinion is that 3 cents is in the cards, you should be able to defend that stance with some numbers to discuss.
Keeping expectations to REAL levels is very important. Hopefully the company will guide analysts to consider this in their models so that we do not see outlandish expectations and a world of confusion when Sirius XM reports Q3 earnings.
Disclosure: I am long SIRI.