Sirius Satellite Radio: Standard Churn Signals Solid Subscriber Growth

| About: Sirius XM (SIRI)

Sirius Satellite Radio Inc. (NASDAQ:SIRI) reminded Wall Street this week just how much of a subscriber-growth machine shock-jock Howard Stern's new home really is. In contrast to XM Satellite Radio Holdings Inc. (XMSR), which tempered growth expectations last week, Sirius raised the bar, saying it expects its customer count to grow to 6.3 million by year-end, a shade higher than its previous 6.2 million target and up from nearly 4.4 million on June 30.

While investors will undoubtedly monitor progress here carefully, another less-discussed metric also bears watching: deactivations.

Normally, consideration of deactivations is embedded in the churn rate, which measures subscriber attrition, or, generally, the number of subscribers that leave a service over a specified period divided by the number of customers during that period. For Sirius, the rate is up, but not enough to ring alarm bells, especially given the modest sequential decline in the second quarter.

On a conference call following its report, management went beyond churn data and discussed its own marketing survey, which showed that customer satisfaction rose to 94 percent through the first week of July from 92 percent at the end of June. It added that 90 percent would recommend Sirius to friends, up from a prior 86 percent level.

Sirius didn't go into detail as to how its study was conducted. Meanwhile, we're not convinced conventionally calculated churn rates tell as clear a story for a company like this as they would for a more mature business. In the case of Sirius, we don't know if low churn percentages mean that the cancellations are of minor significance, or if it simply reflects a mathematical formula in which deactivations are divided by a very-rapidly growing denominator, a subscriber base consisting of many newcomers who haven't yet formed a solid opinion, one way or the other, about the service.

Table B presents a different perspective. It compares the number of new subscribers in a period with the number of incumbents that deactivate. If the number of dropouts grows more rapidly than the number of newcomers, that could raise questions about user satisfaction.

It may be wishful thinking to hope for a near-term return to the low deactivation ratios of 2002 and 2003, when the early adopters were coming aboard.

The percentages in 2004 and through the first half of 2005 probably paint a fair picture of how pre-iPod consumers felt about what was primarily an in-depth music service.

The numbers for the second half of 2005 appear to be distorted by unusual factors. In the third quarter, subscriber growth slowed, probably as people waited for the impending Stern launch; that made the deactivation percentage look high. Conversely, the deactivation percentage was unusually low in the fourth quarter, as the new-subscriber tally against which deactivations are measured were boosted as customers poured in ahead of Stern's imminent debut.

Early 2006 numbers start to paint a more meaningful picture. While the first quarter probably includes some carryover of the fourth-quarter Stern phenomenon, the high level of deactivations in the second quarter — as an absolute number and as a percent of new signups — is a concern.

In a July 24 research report, Bryan Kraft of Credit Suisse wrote that churn is likely to increase at Sirius and XM as a "natural consequence of the auto replacement cycle and the nonconversion of original-equipment automotive [OEM] customers." But presumably, a satellite-radio fan who gets rid of a car will re-subscribe when the replacement vehicle is purchased, so the impact on the churn rates and the deactivation-to-signup ratio ought to be fleeting at worst. To the extent nonconversions — choices by those who receive special satellite-radio deals to drop the service when the promotional period ends — are an issue, investors should be concerned since that would reflect individuals who tried satellite but were underwhelmed.

Even with a worst-case spin, none of this would necessarily be the end of the world. When considering upcoming trends in deactivation, there is reason to hope satisfaction, as measured in Table B, will improve.

Any assessment of consumer views of Sirius starts with Howard Stern, its flagship personality. On the conference call, management indicated Stern will boost promotion efforts later this year. But more newcomers are in the fold and, for better or worse, their satisfaction levels will probably depend on the same factors as those influencing current customers.

Sirius bulls have other pegs upon which they can hag their hats:

* Stern became available via Internet streaming late in the second quarter, so we haven't yet had a chance to see how satisfaction will be impacted by the ability to listen to his live programming even when not near a docked radio unit. It would be very encouraging to see the deactivation ratio decline in the third quarter.
* Another listening enhancement is due in August, with the release of Stiletto, a portable device that allows subscribers to listen live even when on-the-go. That will fill a so-far conspicuous omission from Sirius' hardware lineup.
* There are also new programming developments that should broaden the appeal for those who want things other than Stern: NASCAR, a 24x7 lifestyle-oriented Catholic Channel, entertainment news offerings from Variety, a 30-year archive of Barbara Walters' interviews, a weekly Deepak Chopra health-and-wellness call-in talk show, a weekly talk show with Mark Cuban, and with the start of football season, the first opportunity for post-Stern signups to appreciate Sirius' NFL content.

On paper, these developments should enhance customer satisfaction.

That said, we're also hearing some dissonant notes.

One is the OEM distribution channel. Both Sirius and XM talk of brisk growth on this side of the business, and both proudly trumpet exclusive deals they have signed with various automakers.

Kraft supports the OEM emphasis. In his July 24 report, he suggested that "[t]he draw of satellite radio for the majority of consumer is and will continue to be for use while driving" and that "other uses—wearable, at home, or at work—will be peripheral."

While it's too early to see if developments really play out this way, it is interesting to see management at both satellite firms and Wall Street so keen on this angle.

Considering how much vehicles cost nowadays, we have to wonder whether buyers would allow the tail to wag the dog by letting their choice of auto brand be determined by which company signed an exclusive deal with which satellite radio provider. If it goes the other way, with the primary choice being the vehicle and the radio riding the coat-tails, this might signify lackluster loyalty to one satellite company's content relative to another, a scenario that could diminish the importance of programming in the decision to continue or deactivate.

A second point of dissonance is the stated goal, on the part of both satellite firms, to eventually boost advertising revenue to reach 10 percent of the total.

Arguably, 10 percent may not be high enough to diminish satellite's appeal relative to commercial terrestrial radio. But even if that turns out to be the case — the operative word being "if" — would the companies find it easy to stop trying to grow this revenue source once it actually reaches 10 percent, especially if programming and marketing costs remain high relative to subscription revenue?

Hopefully, management is monitoring the relationship between deactivations and new signups as closely as they tracking conventionally calculated churn, OEM signups and ad revenue trends.

Disclosure: At the time of publication, Marc H. Gerstein did not shares of SIRI or XMSR. He may be an owner, albeit indirectly, as an investor in a mutual find or an Exchange Traded Fund.

Note: This is independent investment and analysis from the investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by

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