Recent Weakness Presents Sirius XM Buying Opportunity

| About: Sirius XM (SIRI)
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Sirius increased guidance on last earnings call.

The company set several records.

Shares dipping to $3.30 reduces downside risk.

I have been long Sirius (NASDAQ:SIRI) for longer than I care to admit. I have been writing about the company for more than three years and commenting for much longer than that at Seeking Alpha. During that entire time I have used covered calls to reduce risk and enhance my return. The recent price decline towards $3.30 once again provides an opportunity to generate double digit returns and yields in excess of 20%.

The earnings report and conference call on Monday had several positives as the company set multiple quarterly records. CEO Jim Meyer reported:

Free cash flow ... $335 million which is the highest level ever produced by our company in a single quarter. subscriber base at 26.3 million and our self-pay subscriber base at 21.6 million. Both of which are record high. ...trial funnel is at a record high of 7.3 million ....35.7% adjusted EBITDA margin, easily the highest in the company's history

and, CFO David Frear added:

We had our strongest quarter ever for new car trial starts at more than 2.8 million and used car trial starts also set a record at nearly 1.2 million. Total trial conversions were also at record levels. ...Adjusted EBITDA grew nearly 31% to a record $370 million.

As a result of the performance, the company modestly increased full year guidance. The original guidance was:

  • Net subscriber additions of 1.25 million
  • Free cash flow approaching $1.1 billion
  • Revenue of over $4.0 billion
  • Adjusted EBITDA of approximately $1.38 billion

Adjusted EBITDA was raised by $45 million to $1.425 billion, and free cash flow and revenue were respectively "increased" to approximately $1.1 billion and approximately $4.1 billion.

The shares initially reacted favorably to the news, with the price rising as high as $3.49 (and even higher in the pre-market) before closing at $3.40. The shares prices have declined to as low as $3.30 today. It's not just the market that is selling. Sirius Director James Mooney dumped more than 90% of his holding following earnings, selling 1,324,891 shares on July 30th, leaving him with 92,070 shares (plus an indirect holding of 9100 as a custodian for child).

There are reasons that insiders sell other than a belief that the shares are overvalued, and it's not a factor I follow too closely. Still, others do care and it was a surprisingly large sale that may have spooked some investors.

How much is Sirius worth? Well, the obvious answer is whatever the market is willing to pay for it. It does generate substantial free cash flow, and I expect the free cash flow per share to approach twenty cents this year. At a $3.50 share price, that's a yield of less than 6% and a multiple of more than 17.5x. At a $4.00 share price, that's a yield of less than 5% and a multiple of more than 20x.

Could the shares go higher than $3.50, or even $4, by next January? Sure. However, those that choose to be conservative can purchase the stock and sell the $3.50 January call option and pocket a return of more than 10%. As I type this, the shares are off the low of $3.30 and are trading at $3.33 bid and $3.34 asked. The January $3.50 calls are trading at $0.17 bid and $0.19 asked. If one buys the shares at $3.34 and sells the call at $0.17, the net cash outlay would be $3.17 per share.

I would fully expect those shares to be assigned and sold at $3.50 by the January 17th expiration. That would give a cash on cash return of just over 10% - a double digit return. And, since that return takes place in less that six months, the compounded yield is in excess of 22%. Note that a 10% return on the $3.34 share price would require the shares reach $3.67 by that same January date, and the last time the shares closed above $3.67 was January 23rd of this year.

Could someone be leaving some upside on the table? Certainly, but buying that potential upside comes with increased risk. And, there is risk associated with this investment. But that's another article for a future date.

Disclosure: The author is long SIRI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In addition to my long positions, I have January 2015 $4 covered calls written against portions of my long positions in Sirius XM. I also trade blocks of Sirius XM on a regular basis.