Last week I published an article tackling the concept of expectations as they relate to Sirius XM (SIRI). The concept of the article was quite simple. Get people to look at this business as a business that grows rather than betting of "hope" and what the company may or may not do going forward. The article took those that are betting on "hope" head on by demonstrating that is simply not any reasonable mechanism that can propel Sirius XM stock to a $5 price within the next 12 months. Simply stated, the business model does not support that type of growth.
None of this means that Sirius XM can never get to $5, nor does it mean that the company does not represent a good investment. In actuality Sirius XM has great potential. Betting on potential is fine, but we all need to be cautious as well.
Before modeling when and under what circumstances Sirius XM can reach $5.00 per share, there are some things to consider and understand:
- Sirius XM valuation is determined by the MARKET, not what I, or any individual investors feels the valuation should be.
- The MARKET has typically carried a valuation for SIRI, using the EV/EBITDA model, of between a multiple of 15 and 20.
- Media companies are typically valued on EBITDA growth or free cash flow growth.
- Enterprise value is market cap plus debt minus cash. One reader on the last article had this confused, so I want to make sure it is crystal clear.
- Models can and do consider other events. If you are more bullish on potential, then you can simply see it trading at a higher multiple.
- These models consider organic growth, not a change in share price due to something like a reverse split.
Before marching on to $5 per share, let's see where the company currently stands:
As you can see, the company currently trades at a multiple of almost 21. This is typically at the high end of the historic scale that the MARKET values SIRI at. It should be noted that we should be getting new guidance from Sirius XM soon, and that guidance will show a new EBITDA projection. Let's assume that the company assigns 20% growth in EBITDA and guides to $1.1 billion. What would that do to the model?
As you can see, the one simple change in EBITDA suddenly changes the valuation, and thus the premium is trading at. Working with a new EBITDA number is enough to make a meaningful change. Now let's build a model for September of 2013 using some assumptions that are reasonable.
- Sirius XM guides to EBITDA of $1.1 billion
- Sirius XM takes on an additional $2 billion in debt to conduct share buybacks at $2.75.
- The share buybacks would 727 million shares out of the float.
- The company keeps cash at $500 million and uses all other cash to buy back shares. That would allow $1 billion to be used in share repurchases. Assuming that this round happened at $3 per share, the share count would be reduced by another 333 million shares.
As you can see, the very realistic events that could transpire over the coming six months could lead to a $3.25 price and be at a multiple of just above 20. While this is progress, we are still not yet at $5.00 per shares. Now let's model 2014 with some reasonable assumptions.
- Sirius XM will generate $75 million in free cash flow per month.
- This free cash flow will allow about $1 billion to be spent on share buybacks
- Let's assume an average buyback of $3.50 per share.
- This would reduce the share count by another 286 million.
- The company would show 20% EBITDA growth to $1.32 billion
The company is getting pretty close to $5 per share, but is not quite there yet. However, we would now be sitting in 2014, and awaiting new guidance for 2015. Remember, the stock will trade ahead of current values and toward anticipated values once the company issues guidance. Now if the company were to issue 2015 guidance in October of 2014 with EBITDA at $1.584 billion, the dynamic shifts. See the new chart with the only change being new EBITDA guidance.
As you can see, the price target can indeed hit and even surpass $5.00 in 2014 using the traditional valuation models that the MARKET values the equity at. If you feel that SIRI can do better than that, it is quite fine. You simply believe that it can and will trade at a higher multiple.
Now, I know there will be some out there that say that 20% growth is not enough. If we had switched to an assumption of 25% growth in EBITDA through the next few years and arriving in 2014, the price target at a multiple of just over 20 would be $5.75.
Essentially, this equity can see a price of $5.00 in 2014. That represents a double in two years. That is nothing to slouch at, and in fact is impressive by most measures.
Yes, there will be a lot of things that happen between now and then. Liberty Media (LMCA) will be moving forward with their agenda, as will all of Sirius XM's competitors. What this article models is a reasonable approach to longer terms outlooks using reasonable assumptions. There will be those that think things will be more aggressive, and then again, those that see growth slowing.
In the end, it is the MARKET that values any company. By setting reasonable assumptions and goals, you can develop reasonable expectations. As to when Sirius XM can reasonably hit $5.00 per share, the answer is sometime in 2014. Too many people bet on "hope" when it is the MARKET that dictates how an equity is valued.
Disclosure: I am long SIRI.