Sirius XM Radio: What's Wrong With This 'Buy' Recommendation?

| About: Sirius XM (SIRI)
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A Sirius XM Radio (NASDAQ:SIRI) story recently showed up on a news feed that's part of my trading platform. Credited to Street Insider, and provided by Acquire Media, the story was about the strong Seasonally Adjusted Annual Rate, or SAAR, for new car sales during the month of June. The story discussed how Goldman Sachs analyst Matthew Niknam felt about the implications for Sirius XM:

June SAAR and a Goldman Sachs consumer survey both highlighted strong growth at Sirius XM Radio . The two data points have positive implications, thinks analyst Matthew Niknam.

"June light vehicle SAAR of 16.0mn exceeded both GS (15.7mn) and Street forecasts, which we view positively for volume growth at Sirius XM. Notably, this marks the first time since 2008 that auto sales have touched the 16.0mn run-rate," said Niknam.

Many investors in Sirius XM also view the SAAR news as a positive indicator for the stock. And, the stronger than expected consumer confidence - also cited by Niknam - can lead to increased spending, especially for a consumer discretionary item like satellite radio. There was, however, one very puzzling aspect to the story.

Goldman Sachs has a Buy rating on Sirius XM Radio with a price target of $3.50

This is the same Goldman Sachs price target that Niknam set late last year when the price of the stock was trading at about $3 per share. By July 3rd, the date of the recent article, the shares of Sirius XM had reached a post-merger high of $3.63, and the shares had closed at $3.44 on July 2nd. Why would a stock with a $3.50 price target that was trading in the $3.40's warrant a buy recommendation? And why would it be considered news?

Niknam's target is at the upper end of the range of what I consider fair value based on the company's 2013 expected Free Cash Flow (or FCF) of approximately $915 million, although with the price where it sits today, I would only rate the stock a hold. And, as to the significance of the June SAAR, one needs to consider how the Sirius XM subscriber model works. How important are a few hundred thousand extra new car sales? Or, even 1 million additional sales?

Initially, when Sirius XM gave guidance for 2013, it was using annual vehicle sales of approximately 15 million. The forecasts have increased throughout the year, and Edmunds is forecasting 15.5 million light vehicle sales. The benefit of an extra million light vehicle sales would eventually be expected to add about 300,000 subscribers based on a 67% penetration rate and a 45% conversion rate. (That would ignore any increase in losses due to current subscribers replacing their current vehicles.) And, if those 300,000 subscribers were to take the base subscription package of $14.49 per month plus the $1.81 Music Recovery Fee for an average of six months, that would only result in $30 million of additional revenue in 2013.


New vehicle sales are important to Sirius XM, but it does not appear that any unexpected bump in sales will have a meaningful effect on the expected revenue or FCF. As to the buy recommendation by Goldman Sachs, it's puzzling unless the Goldman Sachs plans to raise its price target above $3.50.

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.

Additional disclosure: In addition to my long positions, I have January 2014 $3.50 covered calls written against most of my long positions in Sirius XM. I also trade blocks of Sirius XM on a regular basis and can be expected to write another covered $3.50 call at any time. I have no positions in any of the other companies mentioned in this article.