Sirius XM (NASDAQ:SIRI) CEO Mel Karmazin recently announced that he will step down when his contract expires on February 1st, 2013. Many expected Karmazin to leave Sirius XM, but did not expect the announcement until the upcoming earnings report.
However, the market reacted to news of Karmazin's departure with only mild negativity. It might have simply been a correction from last week's multi-year high now trading just 4% lower. In other words, the market saw his resignation coming and built it into the price.
Under Karmazin's leadership, Sirius merged with XM radio to create a monopoly on satellite radio. He worked deals with car manufacturers around the world to put satellite systems in 70% of new cars. He took the company from near bankruptcy in 2009, when the stock traded for as low as 5 cents per share, to current levels just under $3 and a market cap over $11 billion.
Many also consider him the man responsible for the collapse. When Karmazin took over in 2004, the company traded for over $9. Mounting debt obligations and low cash flow nearly led the company to declare bankruptcy, as they would not be able to pay $175 million in bonds in mid-February 2009. Liberty Media (NASDAQ:LMCA) stepped in and bailed out Sirius XM. In exchange for a 40% stake in the company, Liberty Media provided an influx of $550 million.
With Karmazin leaving, it now seems inevitable that Liberty will take over. Already with nearly 50% of the company, it only needs to grab about $50 million in stock to take control. Liberty Media chairman John Malone said in July that he plans to spin off Sirius once Liberty gains control. I believe, however, a share buyback is more likely.
If Liberty decides to buy back shares, stockholders can expect an increase in their holdings value. Additionally, as it becomes more evident that Liberty will indeed takeover, the price of the stock will go up with a big buyer in the news. However, with earnings next week and a large amount of headline risk I will wait for a better time to buy.
Another risk Sirius faces is Pandora's (NYSE:P) internet radio. In the past year, the company increased content by over 70%. It also further penetrated the automobile market with in-dash internet systems in that include the company's app. Manufactures such as Ford (NYSE:F) and Toyota (NYSE:TM) currently use their in-dash systems as a big selling point. Car owners can use their phone's data plan to stream Pandora through their car stereo. As these systems become more popular, Sirius will have to justify the cost of its service compared to the essentially free Pandora.
In addition, Apple (NASDAQ:AAPL) is attempting to enter the internet radio market. The company could prove a dominant player once it rolls out a product. It already leads the sector in music technology with the iPod and iTunes. If the company can integrate its streaming service into its currently successful products, it may gain enough momentum to find its way into people's cars.
For the time being, I believe Sirius' strategy will continue to pay off. The wide variety of sports and talk programming only available through their service offers it a competitive advantage over Pandora and Apple. By including subscriptions in new car purchases, users get a taste of what Sirius has to offer without noticing the cost.
Sirius is highly dependent on the auto industry. The vast majority of subscriptions come from owners of new cars with satellite receivers installed. The car manufacturer may include the cost of a subscription in the price of the car, allowing owners to sample satellite radio for one to three years. The product is very sticky, and Sirius is able to retain many of its subscribers this way.
Auto sales ought to continue to climb as the economy recovers further. The average age of cars on the road is over 10 years as many Americans have foregone buying a new car in recent years. That number is declining, and eventually may return to the level seen in 2007 of 9.4 years. In addition, rising gas prices give consumers another incentive to buy a newer, more fuel-efficient car.
In October, auto sales look to stay on par with numbers in September. This is traditionally the case, but it is a good sign for automobile manufacturers as they are still in recovery mode. I believe the auto industry will continue to recover and Sirius will continue to increase subscriptions through in-car systems.
With Liberty Media standing by to snatch up stock and a potential buyout once it takes control, Sirius presents a lot of upside to investors. However, many things may go badly for investors. For example, Liberty Media may fail to take control and/or offer a buyback. The market may find the newly appointed CEO unfavorable. New car sales could be lower than expected. Or Pandora and Apple step up the competition more quickly. As I mentioned earlier, there is a lot of headline risk.
Fundamentally, the stock looks strong. Forward P/E is just under 29 resulting in a miniscule PEG ratio of 0.19. Analysts expect EPS to rise by 27% over the next five years. Comparatively, the industry trades at just under 15 times earnings, but a PEG of just 1.3.
The company's margins are superb netting 107% and subscriber growth continues to accelerate despite a price hike for users. Margins will likely improve as the subscriber base grows in the coming year.
Subscriber growth also indicates an increase in free cash flow. Indeed, analysts at Maxim Group increased guidance based on predicted cash flow increase. Currently trading at just 4 times its cash flow over the last 12 months it trades at a discount to its peers that trade at 9.7 times cash flow.
I will wait to see how the market reacts to earnings and if there is any definitive news of a buyout. If earnings cause a negative reaction, it could present a good buying opportunity and a chance to front-run Liberty Media and ride the wave that it will create trying to capture the lowest price possible. But buyer beware, this is one you will have to follow closely.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.