Dissecting Sirius XM's Subscriber Picture

| About: Sirius XM (SIRI)

Any subscription business has common goals of A) obtaining subscribers, B) keeping subscribers on board, and C) trying to maintain growth. It is not always an easy task, and as the numbers grow the challenges and rewards do as well. For Sirius XM (NASDAQ:SIRI) these challenges and potential rewards also exist.

As a subscription based business Sirius XM has actually made it through the toughest times and is now at a point where every incremental subscriber addition is very accretive to the bottom line. Essentially it takes a certain amount of subscriptions to pay the bills, a certain amount to fuel growth, and then every other subscription is gravy. While that may seem overly simplistic, it is essential to understand this. Simply stated, Sirius XM is now in the gravy phase of its growth. Even with that though, certain challenges, such as a morphing competitive landscape exist.

With the company having just reported its Q3 earnings, and subsequent filing of a 10Q, we can learn a bit about the subscriber side of this business.

In Q2 of 2012 Sirius XM reported subscriber gains of 622,000. That has been well established. In Q3 the company reported subscriber gains of 445,000. This is also well established. Auto sales were lighter in Q2 than in Q3, so the lower number should not come as a surprise, but if you dig a bit deeper you will notice some pretty compelling things:

Gross Additions in Q2 were 2,481,004 vs. Gross Additions in Q3 of 2,421,586. Essentially the delta between the Gross Additions in the 2 quarters was just 60,000. How is it that the delta was so small, yet the reported numbers differ by about 180,000? The answer is churn and deactivations.

Deactivations in Q3 were 1,858,962 in Q2 vs. 1,975,665 in Q3. I have long stated that it is very important for Sirius XM to keep churn at 1.9% this year. In Q3 the company reported churn of 2%. Yes, CEO Mel Karmazin qualified that by saying churn was at 1.95% rounded up to 2%, but even half a point can really become meaningful when you are dealing with numbers in the millions.

Another factor is penetration rate and conversion rate. The penetration rate tells us the percentage of new cars that get satellite radio installed. The conversion rate tells us the percentage of promotional subscriptions that convert to self-paying status.

The penetration rate for Sirius XM has typically been between 64% and 67%. In Q3 the rate was 67%, the higher end of the scale. The conversion rate dropped in the most recent quarter from 45% in Q2 to 44% in Q3. Again, it does not seem significant, but with big numbers the impacts can be material.

The key for investors is knowing these little things that can carry a substantial impact on how the company success is perceived. Obviously announcing 622,000 subscribers is far more impressive than announcing 445,000, but the fact is that any subscriber additions are great for the bottom line.

The elements to watch for are keeping the churn stable at 1.9%. A churn rate of 2% will not kill the numbers, but does change perception a bit. We also want to see the conversion rate stable at 45% or better. The 44% reported in the most recent quarter does not have a huge impact, but again changes the numbers enough to change perception. We also want to see the conversion line hold at 44%. If it drops to 43% we would have to consider that a trend is starting.

The ace up Sirius XM's sleeve is the used car market. With 7,000 dealers participating and more and more satellite radio equipped used cars on the market, these gross additions will help with subscriber acquisition costs as well as the bottom line. It is the used car market that enabled gross additions to remain the same even when the new car sales from quarter to quarter were about 400,000 units different.

The underlying truth here is that It could be argued that the 445,000 subscribers added in Q3 were more valuable than the 622,000 added in Q2. For 2012 we should see gross additions at about 2 million. I expect a similar number in 2013. That does not mean company growth is stalling though. Remember, each addition is gravy at this point.

Disclosure: I am long SIRI. 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.