There has suddenly been a lot of debate about where the share price of Sirius XM (SIRI) is headed in the next few years, and how to determine a model for it. Articles, comments and chatter on the web range from five dollars to double digits. However there is one thing that almost everyone agrees on: Sirius shares are headed higher. With or without CEO Mel Karmazin, the shares will jump. If Liberty Media (LMCA) Chairman John Malone can not work out a deal with Karmazin, and the FCC does approve the Liberty application for De Jure control of Sirius, it will still head higher.
Mr. Karmazin in my opinion, is a lot like Steve Jobs. He has put his heart and soul into Sirius and it shows. The company came out of the doom and gloom of near bankruptcy to become the largest radio company on earth under his leadership:
Forbes also points out the growth in the company since Karmazin took over: "Sirius had 660,000 subscribers when Karmazin signed on; today it has 22 million. Fewer than one in five new cars came equipped with a satellite radio then; now two out of three do. Sirius was bleeding at the rate of $670 million a year; this year it expects to generate free cash flow of $700 million and is closing in on $1 billion in EBITDA. Its annual revenues have zoomed from $67 million to $3 billion."
And those numbers, which came from a report this past Spring, are even higher now. But how does anyone decide how to determine the future value of the company. Every company that I ever worked for used projected earnings and income to determine success and value. We do not have the new 2013 guidance for Sirius yet. However, in the 1980's a few companies came up with the term EBITDA which means earnings before interest, taxes, depreciation and amortization. Some investors use this to help determine the value of a company. EBITDA = Revenue - Expenses (excluding interest, taxes, depreciation and amortization):
A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA is often used as an accounting gimmick to dress up a company's earnings. When using this metric, it's key that investors also focus on other performance measures to make sure the company is not trying to hide something with EBITDA.
Now, I did not set out to ruffle any feathers when I began my research on EBITDA. Rather, it began as my own due diligence. But there will be a lot of feathers ruffled over this article. Because the deeper I dig into this subject the more negative information I find. According to an old Wharton article from 2002, there are many reasons why EBITDA should not be used alone to determine the performance of a company:
John Percival, an adjunct finance professor at Wharton, is one who never quite accepted EBITDA as a valid tool. In some of my classes, I call it EBIT Duh, he says. It is the lazy analyst’s cash flow and it is dangerous.
Other accountants are also raising issues about EBITDA. Ben Neuhausen, the national director of accounting at BDO Seidman, notes that EBITDA continues to be valuable. But it needs to be used with care. As a measure of performance it is not a substitute for net income. Just as EBITDA ignores cash outlays for capital expenditures that can be significant, it also ignores interest and other specified expenses that can account for a large part of a company's cash outflow.
I know that Mel Karmazin uses the term a lot on the conference calls, and other commenters and writers use it. And as the definition says, it is a measure of performance, but it is not a substitute for net income. It is a starting point for investors. Consider the famous statement about EBITDA made by Warren Buffett......about ignoring the "D" in EBITDA. This is how he put it in his 2002 letter to shareholders:
"Trumpeting EBITDA is a particularly pernicious practice. Doing so implies that depreciation is not truly an expense, given that it is a "non-cash" charge. That's nonsense. In truth, depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front, before the asset acquired has delivered any benefits to the business....Does management think that the tooth fairy pays for capital expenditures?
So two identical companies can have the exact same EBITDA, but one might have older equipment which would be very costly to replace. And then there is another tool that some investors developed from EBITDA that can be just as deceiving. And that is the Enterprise multiple, also called the EBITDA multiple. This is Enterprise value divided by EBITDA:
Keep in mind that enterprise multiples can vary depending on the industry. Therefore, it's important to compare the multiple to other companies or to the industry in general. Expect higher enterprise multiples in high growth industries (like biotech) and lower multiples in industries with slow growth (like railways).
Also there are a lot of different ways to calculate the Enterprise Value. Online I found several different formulas used to calculate EV, which could give anyone a free license to be creative depending on their agenda. This is not to say all analysts would do this on purpose. Some may figure it the way that they consider it should be calculated. But then they should compare other companies the exact same way. And certain companies have different variables that can affect them specifically. For instance on Investopedia, this is their interpretation of the equation for EV:
A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents....Think of enterprise value as the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company's debt, but would pocket its cash. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation.
That sounds pretty easy, right. Just plug the numbers in and divide the answer by EBITDA. This statement says that EV is a much more accurate way to decide a company's value, because it includes debt. But there are a multitude of problems. First not every analyst adds in the minority interest and preferred shares. And a lot only subtract the cash, and not cash equivalents:
Enterprise value is calculated as follows:
Market Capitalization + Total Debt - Cash = Enterprise Value
Some analysts adjust the debt portion of this formula to include preferred stock; they may also adjust the cash portion of the formula to include various cash equivalents such as current accounts receivable and liquid inventory.
As you can see it says "some" analysts adjust the debt and cash. But not all of them do. If you use just the "plain Jane" version of this formula, you could change the answer completely. And then consider the controversy over the market capitalization at a company like Sirius. According to the 10Q filed last month, there are 6.506 billion shares, which includes the Liberty preferred shares. This would make the market cap $16.525 Billion. Most financial sites only list the common shares and do not include the Liberty preferred B1 shares in the totals.
For instance NASDAQ lists the market cap at $13.127 billion, while Yahoo Finance shows it to be $9.74 billion. And then there are several people that disagree with what the company shows as far as total share count. I have seen numbers from 6.5 billion all the way to 7 billion, and everything in between. However no one has provided a link (for verification) to those numbers, which do change daily. So I can only go with the official share count given by Sirius which makes the market cap $16.525 billion. But consider all of the other investors trying to make this equation work with all of the different numbers. And what about the NOLS. They are worth a fortune, and yet where are they in the equation? Because of this the ratio may not work for companies that don't pay taxes. Consider this statement from someone that loves the EV/EBITDA ratio:
Every Ratio Misses Something - Like Companies With 0% Tax Rates No price ratio is perfect. Bloomberg says Carnival (CCL) has an EV/EBITDA ratio of 10. Now, you might think the "DA" part of a cruise company - since they spend so much on very long lived ships - is going to be the most important thing to worry about when thinking about the EV/EBITDA ratio. And that would be true, except… Cruise companies don't pay taxes. So when a cruise company and a railroad both have an EV/EBITDA of 10 - the railroad is going to pay 35% of its income to the government, the cruise company is going to pay 0%. That's a hell of an asterisk.
So when comparing the Sirius ratio to another media company that will pay taxes, the ratio is not any good. I know there are probably some accountants reading this, that could add to the conversation. But according to my research EBITDA is not approved by GAAP:
EBITDA is not a GAAP approved accounting measure because EBITDA neutralizes the effects of a company's financing and accounting decisions.
Because of this, I can not see using that ratio to determine the future value of Sirius. However don't expect the company to stop reporting it. Too many investors are used to using it. Just know that when you hear Sirius has the same EBITDA as a competitor, they probably will have to pay taxes out of it, and Sirius can use its NOLS. As I have said in many recent articles, the future share price will depend on what actions Liberty takes. In my opinion the Sirius share price will continue upward based on the strong revenue, sub growth, and superior programming.
In the last two years it has grown 120 percent. Forty percent in the last year. If the growth continues at 40%, then the share price would be $3.55 a year from now, and $5 two years from now. However, that does not take into account a share buyback, which should happen as soon as Liberty gets control. It is very likely that at least $1 billion will be used for a buyback in the next year, and that is very conservative compared to the rumors that I have heard. If the company pays Liberty that money for some of the shares it purchased at an average of $2.33 (I just pulled that number out of a hat, because the cost was all over the board for the shares bought), that would buy 430 million shares. Taken from the current (documented diluted) share count of 6.5 billion the new count would be 6.07 billion shares. Theoretically the market cap one year from now would be $23 billion divided by the new share count of 6.07, which would make the new share price $3.80 in one year. In this model the 40% is very aggressive. However, the company has grown more than that each year since the crash.
All of these "Pro Liberty" people think that Liberty will surpass the job that Karmazin and the current Sirius management has done, so I look forward to the new Liberty team beating these numbers. And I also think the buyback amounts are extremely conservative. Because of this, it would not be unreasonable to see $5 a share a year from now with an aggressive buyback. For instance if the first buyback is more aggressive, and doubles the amount to buy back one billion shares, the new share count would be 5.5 billion shares. That would theoretically make the new price $4.18. Obviously this is all speculation. Things could go both directions. And when a buyback is announced, the share price could immediately jump on the news.
But Liberty has not gotten the green light from the FCC yet. They have still not moved at all on the Liberty application. There have been some investors that think Liberty is stuck in limbo because the company failed to get the required signatures from Sirius Management. That is very possible. What would it do to the stock if Liberty were not approved? I think it will go up either way. The company is just doing too well.
Disclosure: I am long SIRI.