The trade secrets series has been written to help investors better understand some of the dynamics at play that make Sirius XM (SIRI) a success. Understanding why a company enjoys success should be a key element in any investors due diligence. The reasons are numerous, but the most obvious is protecting your investment. Once you understand why a company is successful you know some key items to watch for going forward. This could help an investor develop entry and exit points.
If you have not yet had a chance to do so, I would suggest that you read those parts before continuing on. For readers that are interested in part four, and what it covers, here goes:
Sirius XM is a Success Because Management Watches The Metrics That Matter
This is an interesting subject. It tackles short term success vs longer term success. There will be parts of this article that frustrate longs and company management, and parts that those same people will celebrate.
As with many things in life there needs to be a balance. With business, sometimes that balance is difficult to obtain. Is performing well this quarter or this year more important than the longer term performance of 3 years or 5 years down the road? Is a sacrifice made today to keep things looking good worth it down the road? These are difficult questions that every business manager must address.
As an investor in Sirius XM, and as a consumer of Sirius XM, there are times when I love current management and times when I get very frustrated with it.
For example, Sirius XM does not have the best record when it comes to customer service. After the merger, in an effort to keep the company afloat and hit the numbers that the street was expecting, management trimmed back customer service and sought out less expensive outsourcing deals. Doing so fit into the short term goal of producing merger synergies to match expectations, while the longer term impact was a higher number of people dis-satisfied with the service. The investor in me loved management. The consumer side of me was frustrated.
Another example is the very real cutbacks Sirius XM made in the DJ's, news crews, and programming directors that the company had. The cost savings were substantial and helped the bottom line. The bad side was that the programming was more homogeneous and not quite as good as it was before. Live DJ's were cut back to obvious pre-recorded intros, and the product in my opinion suffered. Again, the investor in me loved seeing cost savings. The consumer in me was frustrated.
A third example is in areas such as retention. It is great to keep subscribers on board. However, the company needs to be careful about how they do it and how often they do it. Sirius XM has been masterful at playing that line quite well. In fact, it is an area where management excels. You see, they have to be able to show growth at certain levels. Sirius XM wants to improve average revenue per user (ARPU), while at the same time trying to keep churn in check. Essentially management is tasked with figuring out when to be aggressive with retention and when to back off.
We saw a prime example of this in the fourth quarter of last year. Sirius XM announced that they beat subscriber guidance. Most investors celebrated that fact. Looking deeper at the quarter, ARPU went down. What that means is that retention efforts were high. It was the perfect quarter to show lower ARPU because the quarterly report is actually an annual averaging out the entire year. You had to dig a bit to realize what happened. That is smart management. That is management that knows where the line is at all times.
In 2012 we have seen retention efforts remain strong. One reason is that due to the law of large numbers, 2.0% churn represents a higher absolute number with each passing quarter. In other words, it takes more and more gross additions to allow a churn rate of 2.0% to remain there. For 2012 Sirius XM has been reporting churn at about 1.9%. The fact is that this is where the company needs to be. If churn edges up to 2.0% again, the result would not be pleasing. Sirius XM essentially manages the quarter to get to the desired result. Again, smart business.
For a few years now Sirius XM has been able to pull off some pretty impressive feats and grow the company to a point of great profits and great potential. However, if you look back, there have been some compelling things that transpired to allow that to happen. The first phases of growth came with adding OEM contracts. These allowed the company to produce impressive subscriber metrics at a time when they could not announce impressive earnings, free cash flow, or EBITDA growth. These OEM contracts, and the subscribers provided allowed investors and the street to see potential and thus invest.
The second phase of growth was the implementation of the music royalty fee. Suddenly revenue jumped substantially. Go back and erase that fee from the equation and you are looking at an entirely different picture than what you see today. Read part 2 of this series for a clear explanation of this.
The third phase ( or phase 2A) was the merger, its synergies, and severe cost cutting. This allowed the company to become more efficient and garner better performance in all metrics.
The fourth phase was the recovery of the auto sector. Phases 2 and 3 were enough to allow the company to survive, but this phase was what once again delivered growth.
The fifth phase was the addition of the used car channel. The company had been installing radios long enough to really begin to take advantage of this phase. This phase will actually carry very meaningful benefits moving forward.
The sixth phase was the price increase and decrease. I call it an increase and decrease because that is what happened. The base price went up, but the core premium listeners actually saw a decrease. One effect of this new pricing is that it allows the company to have wiggle room when it comes to things like ARPU and churn. Because we can not really measure how much of the pricing change will impact things until it happens, we have no way to really see the impacts on some of the metrics. For example, last quarter Sirius XM announced that ARPU went up 15 cents. They attributed it to the new pricing less the impact of retention efforts. Could it have gone up 30 cents without retention? Does this give the company room to increase retention efforts and discounts because investors and the street have no way to measure and compare? Of course it does. management is smart. They know what it takes to deliver a good quarter.
The big question here is whether Sirius XM's actions to deliver good quarters hurt the longer term prospects. It warrants consideration and discussion, or at least thought. As long as the company can come up with a way to keep every quarter looking good, things will be fine. If they run out of ways to do that, what happens? Vehicle sales will peak in 2015. Another price increase is not likely in the cards as of right now. Merger synergies and cost cutting are about as far as they go (yes, I know they still broadcast on both systems and one day, somewhere off in the future they can consolidate and deliver the balance of merger synergies).
Did Sirius XM wait to long to implement Pandora (P) features and make its Internet delivered service a better product? If the company had gotten to On-Demand earlier could it have made Spotify think twice about its U.S. plans in the same manner Deezer did? Would it have been better to have EBITDA growth at 15% a year ago instead of something over 20% and be on top of the IP delivered mountain? Should money have been spent at the expense of quarterly metrics in getting a competitive IP product to market more quickly? Again, food for thought.
Short term vs. long term. There are impacts. While many readers here probably do not listen to country music, there are some that do. One of the most commented on articles I have on SiriusBuzz is an article about Bill Mack leaving Sirius XM. To this day there are scores of angry consumers. Not a week goes by where I do not get a comment or e-mail about Bill Mack. Allegedly he left because Sirius XM made the decision not to renew his contract. While it was one of several programming cuts that likely saved money, it has scads of consumers upset. There are scores upon scores of people that are still upset about the removal of BBC Radio 1 from the satellite feed. The outlash was so strong that Sirius XM brought it back on the Internet service. Is saving that money to make a quarter look better worth the angst of subscribers? How many "casualties" is an acceptable number.
I can not say for sure whether some of the consumer related decisions are not detrimental in the longer term. Verizon once got me so aggravated that I cancelled 3 cell phone plans on the spot. It was literally three years before they earned my business again. A scorned consumer is not a good thing. Only time will tell about the impacts of some of these things. Some of these items that impact consumers, in my opinion, are not handled as well as the financial metrics. In fairness, Sirius XM has done a lot to improve the consumer experience as well. They improved the NFL deal, added over a dozen Latino channels, improved the IP service, and have been active with the Town hall series and artist specific channels. Do these offset some of the other things? Again, time will tell.
Where Sirius XM has been great and successful is in managing the results quarter after quarter to show growth in important metrics such as EBITDA and Free Cash Flow. They have done a great job at managing the balance sheet in shorter terms. In many cases they have had the ability to even ride out storms until other things recover. This will be the second time Sirius XM has been able to ride the OEM wave with new cars. The company can ride the price change impact for at least another 3 quarters. Simply stated, management is very good at keeping each quarter good with good planning and the help of some timely events and changes. Keeping the ball rolling is the key and management knows how to do this.
Would an investor be right to contemplate how long that ball can roll? Sure, it is healthy to think about that. Thus far management has been successful at keeping the short term looking good as well as the outlook. A new era could be ushered in with Liberty Media's (LMCA) quest for control, and this could be a very different company a year from now. A lot is riding on the vision, management style, and desires of Liberty Media. What we know, is that for the next few years Sirius XM currently has the advantage of a used car market that is growing in the number of satellite equipped cars, a few more quarters of the price change getting absorbed, a few of years until the new car market peaks, and several years until they need to launch satellites. That spells good quarters ahead. Let's hope that however Sirius XM is managed when Liberty completes its bid for de jure control that they are as effective at balancing the balance sheet as current management (and current management may stay in tact), and perhaps a little better at some of the consumer driven items.
Additional disclosure: I have no position in Pandora