My first article on Seeking Alpha almost a year and a half ago focused on the subscriber activity metrics - penetration, conversions and churn - of Sirius XM Radio (SIRI). It is a topic that remains important to Sirius XM investors since these metrics drive the revenue, and ultimately the earnings and Free Cash Flow, of the company. These metrics are well controlled by the company.
Some of these controls are obvious and have been discussed openly by the company management. Penetration, the percentage of new vehicles that come equipped with satellite radios, is tightly managed by the company to ensure that radios are installed only in those cars that have a reasonable chance of converting from a trial subscription (paid promotional or free trial) to self pay subscription. Sirius XM uses its historical experience and has been able to keep the conversion percentage right around 45% for quite some time. When it has ticked up or down, it is usually the result of the model mix manufactured and sold by the OEMs in a particular quarter.
Somewhat less obvious is the way that the company has managed the cancellation of self pay subscribers, or self pay monthly churn. From anecdotal evidence in the comments section of Seeking Alpha articles, we see that Sirius XM tries to keep customers from canceling by offering retention discounts. This comment is from a recent article by Spencer Osborne:
muckdog Comments (42)
Well, I got a 3-month free trial with my new car. The programming is good, but not worth the money they want for it. They eventually call you with a $4.99 a month offer. But even that's not really worth it.
It is not all that different from a comment on my first article:
nothing in the analysis on how they keep offering lower promotional rates each time i try to cancel... this keeps the renewals up but the revenues per renewal are lowered...
These are not isolated instances. In the Q2 conference call last year, this exchange took place:
Bryan Kraft - Evercore Partners Inc. - … And then also, I wanted to see if you could just comment on, I think in the press release, you mentioned increased retention discounting affecting ARPU. Can you just discuss kind of the level or the proportion of customers that you're having to give retention discounts to currently versus, say, a quarter ago or a year ago?
David Frear - Chief Financial Officer and Executive Vice President
And on the subscriber retention discounts, … following the merger, we came to the conclusion that what was being trialed in essence with subscriber retention programs on the XM platform was pretty smart business, that it seemed to be a very successful way of either converting customers from OEMs or convincing customers who were thinking of leaving to stick around. We find that, after some initial breakage at the end of that discounted plan term, that the subscribers, for the most part, overwhelmingly stay with us, and then they churn at the normal self-pay rate. So directly to your question, it's about 14% of the self-pay base. And it's -- the rate of increase has been -- has slowed considerably in the course of this year, that when we expanded it to the Sirius platform sort of around the late part of '09, we had some rapid expansion in it, but it's good, smart business for us. You take a little bit of money off the price. You convince a subscriber to stay. It's obviously good to get the money. And then when they come out of that promotional plan period, again, they look like a regular customer that churns at 1.9%.
There are several points for investors to consider. First, retention discounting is a tool used by Sirius XM to manage both conversions and churn. Second, it is a tool that increases revenue, but reduces Average Revenue Per User, or ARPU, another subscriber metric. Third, retention discounting was still increasing, although at a reduced rate. So, what has been taking place this year?
From the most recent 10Q for the third quarter where the increase in ARPU was discussed:
...These increases were driven primarily by the increase in certain of our subscription rates beginning in January 2012, and an increase in sales of premium services, including Premier packages, data services and streaming, partially offset by an increase in subscriber retention programs,...
This is not an isolated incident. The phrase "partially offset by an increase in subscriber retention programs," has been used to describe ARPU changes each quarter this year. What is not known, is whether or not the "increase" is simply due to having more subscribers or whether it is used to indicate an "increase" in the percentage of subscribers receiving the discounts.
In addition to the information in the 10Q, the Q3 conference call held last week included the following exchange about the uptick in churn from 1.9% to 2.0%. (Thank you Bryan Kraft for continuing to ask questions about churn.)
Bryan D. Kraft - Evercore Partners Inc., Research Division - ... First on churn, I know it's within the range that you've given of 1.8 to 2.0 at the upper end though. I was wondering if you did anything differently in the quarter in terms of retention that may have led to stronger ARPU and a little bit weaker churn? ...
Mel Karmazin - Chief Executive Officer and Director - Okay. On the churn question, really nothing different in the quarter. Nothing different in our practices that as the economy continues to improve a little bit each quarter that non-pay continues to go a little bit better. The change in the rate of churn is, sort of, within the rounding. So there's really no meaningful differences in the trend in churn. We continue to invest in the call center sort of tools and to retain every subscriber that we can.
...the churn actually -- I thought somebody might raise that question, okay? Was actually 1.954, okay? But for a little bit, it would have rounded down to 1.9. And the other thing that's relevant is that in the month of September, which is the most recent month of the 3, the churn was 1.82.
If the churn was 1.82% during the third month of the quarter, what was the average for the first two months of the quarter? Since we know that the churn for the quarter was 1.954% per month, and the third month was 1.82%, then simple algebra
(1.82% + 2x) / 3 = 1.954% and solving for x gives:
[(3 * 1.954%) - 1.82%] / 2 = 2.021% average churn for the first two months of the quarter.
It is likely that the average for the first two months of the quarter was slightly higher than the 2.021% calculated above because the average number of self pay subscribers used to determine churn should be growing throughout the quarter.
For those that are skeptical about management's ability to control conversion rates and churn, consider this:
- The 10Q states ARPU was negatively affected by an increase in retention programs. Increases in retention programs mean that more customers are given discounts to remain self pay subs (reducing churn) or convert from trials to become self pay subs.
- There was a sharp decline in churn during the third month of the quarter. Considering the relative stability of churn over the past few years, and the size of the self pay subscriber base, I find a variance of 0.2% to be significant.
Churn and conversion rates have a big impact on the rate of growth of subscribers. When this growth comes at the expense of ARPU, investors should take notice. I applaud management's ability to grow subscribers, limit churn and grow the revenue. I just wish they were a lot more open about the number of subscribers receiving retention discounts.
Disclosure: I am long SIRI.
Additional disclosure: I have $3 January 2013 covered calls against most of my Sirius position, as well as some $2 and $2.50 January 2013 and $2.50 December covered calls. I may initiate (or close) a buy stock/sell option position in Sirius, at any time. Also, in addition to long term holdings, I have recently begun day-trading 10,000 share blocks of Sirius XM and may continue to do so.