Sirius XM (SIRI) has seen an impressive run lately. It has been fueled by the anticipation of several things as this company moves in on closing out 2012 and beginning 2013. Analysts are posting some impressive price targets on Sirius XM and those targets are based on models that carry certain assumptions relating to growth in EBITDA, growth in free cash flow (FCF), growth in subscribers, and even share buybacks.
What we have now is an established ceiling based on estimates but no real floor to provide the safety net that gives analysts, investors, and the street confidence about assumptions.
When looking at media companies there are typically two ways to value them. EBITDA growth and free cash flow growth. If a company grows EBITDA by 25% year over year, it can be thought as reasonable that an enterprise value to EBITDA ratio can deliver a multiple of 20 to 30. The same type of logic can apply to a FCF model.
With Sirius XM the company has typically traded at an EV/EBITDA multiple of between 15 and 25. Usually it will at some point go down and test the 15 multiple, and by contrast will rise up to the 25 multiple. The equity usually likes to be in the comfort zone of a multiple between 17 and 20.
For traders, watching the multiple can usually give a decent indication of a bottom and a decent indication of a top. Right now we are in that tricky period where it appears that the 2012 guidance will be met with relative ease, but we do not yet have the 2013 guidance to help establish the new baseline for Sirius XM. It is not a huge deal, but it does offer something solid to compare a model to. Essentially it is important that we get this information sooner rather than later because the company is already testing the proverbial limits of a multiple when compared to 2012 guidance.
To illustrate this I will show several EV/EBITDA models and the multiples that correspond:
Current Model Based on 2012 Guidance
As you can see, this model has the current multiple at 24. This is the high end of the traditional scale. However, the street is aware that these numbers will be met, and is anticipating that new guidance will be enough to, at a minimum, bring the multiple down to a more typical level from which to build. Building up to a 24 multiple from 17 is one thing. Building higher than a 24 multiple is another.
Now let's look at the data with a simple adjustment to only EBITDA:
Current Model With New EBITDA Guidance
As you can see, with about a 20% adjustment to EBITDA guidance the EV/EBITDA multiple drops down to a very reasonable 19.66 at current prices. This makes perfect sense on a valuation basis. The EBITDA guidance shows about 20% growth, and the equity would be trading at a multiple of about 20. Now let's look at some price appreciation in the stock and see what price the equity could reach to deliver a similar multiple of 24 that we are currently trading at.
Current Model With New EBITDA and Adjusted Price To Reach A Multiple Of 24
As you can see, this new guidance gives an implied peak of $3.65. Remember, this is based on a 20% rise in EBITDA guidance from 2012 to 2013. We have not applied other assumptions such as share buybacks, added debt, or even the chance that EBITDA Guidance for 2013 is 25% instead of 20%. Let's use these same models using a 25% boost in EBITDA.
Valuation Model With EBITDA Growth at 25%
Compared to the 20% growth chart, the multiple is now 19.33 rather than 19.66. What price could the equity reach and have a multiple of 24?
Valuation Model with EBITDA at 25% and a Multiple of 24
The equity can now reach a multiple of 24 at a price of $3.73. Can you see where analysts are now taking their models? What happens if we see some added debt to accomplish a share buyback?
Valuation Model At 25% EBITDA Growth, Added $1.5 Billion in Debt, and Removing 1 Billion Shares
As you can see the multiple went down to 17.95. That leaves room for growth. So at what price could we see a multiple of 24 again?
Valuation Model At 25% EBITDA Growth, Added $1.5 Billion in Debt, Removing 1 Billion Shares, and Multiple of 24
As you can see, the new price target becomes $4.12. That is above the highest current estimate by analysts.
Bear in mind that I left the cash on hand at $800,000,000 throughout each of these models. If there is more cash on hand the enterprise value drops. What I have assumed is that the company keeps a healthy amount of cash on hand, and uses all other cash toward share buybacks. The purpose here is to illustrate the differences getting new guidance and how certain assumptions impact the valuation.
Some investors get scared about the idea of new debt, but the reality is, as long as the company can handle it, it is good for the valuation. Further, if they can refinance some existing debt at lower rates on top of the debt for share buybacks, it would be good for free cash flow.
The key here is getting the 2013 guidance so that analysts, investors, and the street can establish a baseline for models. In many ways, it is quite possible that the new guidance could trigger some additional price targets upward and that we could have several analysts with targets at or above $4.00 per share.
In my opinion, one of the key elements of the Sirius XM Q3 conference call needs to be guidance for next year. I think you can see why.
Disclosure: I am long SIRI.