Sirius XM: Paying A King's Ransom For The Widest Of Moats

| About: Sirius XM (SIRI)

Sirius XM (NASDAQ:SIRI) has a great business model: providing entertainment to a captive audience. Sirius XM listeners are in their cars, either driving or as passengers. The driver can't watch TV or play games or work, and while in theory the passengers could do those things, in reality, it's not really practical, with the possible exception of children.

Thus the only competition to listening to Sirius XM radio is watching the passing scenery or listening to local radio, plus for some people, internet radio services.

Sirius XM versus the cable guys

Sirius XM has it even better than cable companies in that respect, since although cable companies are geographically concentrated and thus only face weak competition from each other, they do have to compete with other sources of entertainment. These include everything from playing video games, surfing the web and reading Seeking Alpha, reading a book and going out.

The biggest downside of Sirius's business model compared to cable companies is paying auto companies to install satellite radio equipment in cars, including subsidizing any promotional subscriptions, combined with high churn of 1.8% a month. The costs of installing Sirius's equipment include:

...hardware subsidies paid to radio manufacturers, distributors and automakers, including subsidies paid to automakers who include a satellite radio and subscription to our service in the sale or lease price of a new vehicle; subsidies paid for chip sets and certain other components used in manufacturing radios; device royalties for certain radios and chip sets; commissions paid to automakers as incentives to purchase, install and activate satellite radios; product warranty obligations; freight; and provisions for inventory allowances attributable to inventory consumed in our OEM and retail distribution channels.

Unlike cable companies, which lease their equipment to subscribers as part of the subscription package, but then require that they return it if they cancel their subscription, Sirius XM does not - and cannot - demand the return of the satellite radios installed in cars.

Every time someone sells their car and buys another one, there is a risk that they will cancel their Sirius XM subscription. This is because if they buy a new car with a Sirius XM radio installed, it will come with a new free trial. If they buy a used car that doesn't have a Sirius XM radio installed in it, they may decide not to go to the bother of installing one, again leading to a cancelled Sirius XM subscription.

Since people change cars more frequently than move home, this leads to greater churn in Sirius XM subscriptions compared to cable subscriptions.

The threat from internet radio

Sirius XM has enjoyed an enviable position since Sirius Satellite Radio and XM Satellite Radio merged in 2008. But the honeymoon may soon come to an end. As mobile data costs plummet and data allowances soar, listening to radio via internet steaming services will become viable. Pandora (NYSE:P) is clearly the biggest current threat, although Apple's (NASDAQ:AAPL) ITunes radio is another.

Pandora has already reported 2.5 million automobile activations, quadruple the number in 2012. That compares to about 26 million active Sirius XM listeners. Interestingly, both Sirius XM and Pandora now have roughly equal shares of the U.S. listening market, with Pandora at 7% and Sirius XM at 8%. Now it isn't surprising that Pandora is gaining on Sirius, because Pandora offers either totally free ad-supported radio or ad-free radio for just $3 per month - 20% of the cost of a Sirius XM subscription.

Pricing power

Sirius XM doesn't seem to enjoy the same pricing power as cable companies: Sirius XM has raised prices twice since 2008: from $12.95 to $14.99 for an average annual increase of 3 percent, or only slightly above the rate of inflation compared to cable companies increase of 6%.

Sirius XM has about 26 million subscribers and plans on adding 1.5 million net self-paying subscribers annually, for a growth rate of 6%. This is consistent with Sirius's subscriber growth rate of 7% since the merger in 2008. Since Sirius's long term revenue growth rate is simply subscriber growth multiplied by any subscription price increases, Sirius XM revenue growth will be limited to single figures going forward.

Valuation compared to cable companies.

Metric Sirius XM Direct TV (DTV) Dish (NASDAQ:DISH) Comcast (NASDAQ:CMCSA) Time Warner (NYSE:TWX)
Market cap/$B 21.5 36.0 26.5 135 63.1
Enterprise Value/$B 24.5 53.3 30.2 176 80.6
Trailing P/E 48.4 13.2 36.4 21.6 17.0
Forward P/E 29.4 11.8 29.5 18 16.4
PEG ratio N/A 1.29 2.17 1.08 1.5
P/S 5.83 1.15 1.84 2.13 2.14
P/B 7.6 N/A 37.7 2.73 2.12
Enterprise Value/Revenue 6.64 1.71 2.11 2.77 2.74
Enterprise Value/EBITDA 19.3 6.89 10.6 8.38 10.2

Source: Yahoo Finance

Unfortunately Yahoo Finance doesn't give a PEG ratio for Sirius XM, but I've posted Sirius's last few years of financials, courtesy of Morningstar.

As you can see, Sirius XM has grown the top line at a respectable 10% clip since 2009; operating income has grown more quickly but has also decelerated just as strongly. Full year figures for 2013 are going to be about $1.1 billion in operating income. Based on this trend, I think going forward over the next 5 years, Sirius XM will struggle to grow operating income above 20% a year.

With a forward P/E ratio of 30, and an Enterprise/ EBITDA ratio of 19, Sirius XM is too expensive for my taste.

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.

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