When the US auto sales data had been released for the past several months, Sirius XM Radio (SIRI) investors received a welcome distraction from the ongoing maneuvers by Liberty Media (LMCA) to wrest control of Sirius XM. The FCC applications for de facto and de jure control of the licenses, the execution of forward purchase agreements, the open market purchases, sales by insiders -- it all fades into the background as new car sales take center stage. Instead, discussions ensue about the Seasonally Adjusted Annual Rate ("SAAR") of vehicle sales takes center stage and how many cars are actually sold and delivered.
Sirius XM investors have long known that the company's fortunes are tied to the auto sector. The new car sales bring new subscribers and the new subscribers bring in the revenue. And it's not just the SAAR number that is important when trying to determine the full year performance, but also the actual number and mix of car sales that take place.
August results fit the pattern of improving sales. Headlines tout the strong results:
Reuters: Auto sales post best August in five years
Los Angeles Times: August auto sales rev up 20%
Forbes: U.S. Auto Sales Speed Up In August: Ford, GM And Chrysler Book Double-Digit Gains
CNNMoney: Car sales post strong August
The articles discuss growth rates of 20%, annual sales rates of more than 14.5 million vehicles and strength in sales of pick-up trucks at Ford (F), General Motors (GM) and Chrysler or fuel efficient vehicles from Toyota (TM) and Honda (HMC). These articles also list a variety of reasons for the recent strength, including pent up demand from a weak July, availability of better and easier credit terms, an improving labor market, improvements in the housing market helping the sales of large pick-up trucks, and increasing consumer confidence.
So, why, with all this good news about SAAR, wasn't there more of a reaction in the price of Sirius XM stock? It's certainly possible that the good news had already been factored into the share price. Or, it's possible that something else is going on, and that new car sales are no longer the key factor for Sirius XM growth.
Consider Sirius XM Key Metrics
Sirius XM provides investors with several important metrics that it uses to measure its performance and project growth. For the growth of subscribers, the company discloses new car penetration rates, conversion rates and self-pay monthly churn. During the most recent earnings conference call, CEO Mel Karmazin stated:
Uniquely, Sirius XM has long-term agreements with all of the OEMs that manufacture and sell vehicles in the United States. As a result, today approximately two-thirds of all new vehicles sold come with a satellite radio and a trial to our service, which by the way consumers love.
So, we know that the penetration rate is 2/3 of new vehicle sales. We also know that of those that have free trials, 45% convert to self pay subscribers at the end of that trial. And, finally, we know that once someone becomes a self-pay subscriber, they enter a pool that cancels at the rate of 1.9% per month.
From the most recent 10Q:
For the three and six months ended June 30, 2012 and 2011, the new vehicle consumer conversion rate was 45%
Average Self-pay Monthly Churn is derived by dividing the monthly average of self-pay deactivations for the quarter by the average self-pay subscriber balance for the quarter.
For the three and six months ended June 30, 2012 and 2011, our average self-pay monthly churn rate was 1.9%
What does this mean for the business model if there are 15 million new vehicle sales? A simplified extrapolation would suggest the following:
15 million * 67% penetration rate = 10.05 million trials
and of those trials, 45% convert to self-pay subscribers, or
10.05 million * 45% conversion rate = 4.52 million new self pay subscribers
More than 4.5 million new self pay subscribers sounds fairly impressive, doesn't it? But we also know that the company will lose a lot of subscribers due to churn. The company began 2012 with 17.9 million self pay subscribers (according to the 10K), and if it loses 1.9% per month, it will lose 3.7 million of those subscribers. (Actually, the total cancellations will be higher than 3.7 million because the number of self pay subs increases each month.)
Surprisingly, even if new car sales reached 15 million this year (which it won't), only 800,000 net incremental self pay subscribers would come from those sales. That's only one half of the company's 2012 guidance for 1.6 million net adds. And, since the company has already generated 1,026,638 net adds in the first half of the year, there is every reason to believe that current guidance will be increased.
What Is Driving Net Adds Higher?
If less than half the incremental subscribers are coming from new car sales, what is propelling the growth at Sirius XM? Many of these subscribers are coming from the used car program, a program that should continue to grow as more OEMs enter the program and more dealers sign on. Responding to an analyst's question about the used car program impact on 2012 during the Q1 conference call, Karmazin said:
... the 1 million used-car additions, you should think of as a gross additions figure and not a net additions figure. So it would be a component of your growth additions forecast for the year.
The company has stated in the past that the used cars convert at a lower rate than new cars, in the mid-30% range. Even if the company manages to convert 40% of these, and even if the number climbs above the 1 million gross adds, this should still only account for about half the remaining 800,000 net adds. The rest of the subscribers would be coming from the retail channel and Internet subscriptions.
Clearly, the new car sales, whether one chooses to look at the actual figures or the SAAR rates, are important to the growth of Sirius XM, but the company has also diversified its sources for new subscribers. It would appear that more than half of the expected increase in new subscribers is now coming from sources other than new car sales.
And, just maybe, that's why strong auto sales had less of an impact on the stock price than investors might have expected.
Disclosure: I am long SIRI. I have $3 January 2013 covered calls against most of my Sirius position, as well as some $2 and $2.50 January 2013 covered calls. I may initiate (or close) a buy stock/sell option position in Sirius, at any time. I have no positions, or any plans to open positions in the next 72 hours, in any of the other companies mentioned in this article.