New Car Sales Should Help Sirius Meet Subscriber Guidance

| About: Sirius XM (SIRI)
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Summary

November was a very strong month for new vehicle sales.

Full-year 2014 sales appear to be on pace for best year since 2007.

New vehicle sales are the main contributor to subscriber growth at Sirius.

Introduction

Over the past three and a half years, I have written hundreds of articles about Sirius XM (NASDAQ:SIRI) and thousands of comments on articles about Sirius. Many, if not most, of the articles have expressed my concern over the cost structure and future growth of the company. Some of those who are very bullish on the company will continue to view these as bearish and recommendations to sell, despite the fact that I have been long the stock the entire time (although the number of shares held has fluctuated greatly) I have been writing comments or articles at Seeking Alpha. (And for those that are new to my articles, it should be pointed out that I have regularly sold covered calls against my Sirius positions, making this an attractive investment for me.)

I prefer to consider my views as conservative, especially when it comes to the growth prospects for the company. It's not that I think the company won't continue to grow revenue, but that I expect the growth to be much slower than others. One comment on a recent article questioned my views about slowing growth and the difficulty Sirius was facing in growing self-pay subscribers. This article will explore the self-pay subscriber growth in more depth.

New Car Sales - The Main Driver Of Growth

New car sales for November came in at more than 1.3 million, raising the year-to-date figure to just over 15 million, numbers that should help Sirius meet or exceed its subscriber guidance figures for 2014. Those subscriber guidance figures, which Sirius updated with the release of Q3 earnings, included an increase in its total net subscriber additions to approximately 1.5 million and a reaffirmation of its net self-pay subscriber additions of approximately 1.25 million.

Not only did the November SAAR rate come in at its best performance in more than a decade, but the year-to-date sales figure is now 5.4% higher than last year. Some analysts think a strong December is also likely since most OEMs have apparently underspent their incentive budgets. Investors may recall that early in the year Sirius management was basing its guidance on 16.2 million new vehicle sales. The Detroit News reported:

Advertising and strong sales are expected to continue through December, putting the auto industry on track to sell about 16.5 million cars and trucks in 2014 - its best year since it hit the 16.1 million mark in 2007.

Many factors are helping push the rate of sales higher. These include the aging fleet of vehicles, increasing household wealth, declining unemployment, loans with low interest rates and longer terms and low gas prices. Some analysts are now projecting these factors could drive 2015 sales above 17 million.

Other Factors Driving Subscriber Growth

New car sales aren't the only positive factor that should be driving subscriber growth at Sirius. Sirius also:

  • Continued to increase its new car penetration rate, now 71% vs. 70% last year, 68% in 2012 and 55% five years ago.
  • Added significant new content in 2014, including The Ellen DeGeneres Show, TODAY Show Radio, and Joel Osteen.
  • Increased the number of dealers in the used car trial program to more than 14,000 from 100 just four years ago.
  • Added lower-priced subscriptions for packages targeted at Hispanics and Osteen at less than half the standard rate.

Despite all these positives, self-pay subscriber growth for 2014 is expected to reach only 1.25 million net adds. How does this compare to recent years?

Year

2009

2010

2011

2012

2013

2014 (Estimate)

Penetration

Rate

55%

62%

67%

68%

70%

71%

Conversion Percentage

45.4%

46.2%

45%

45%

44%

41%

Average Self-pay Monthly Churn

2.0%

1.9%

1.9%

1.9%

1.8%

1.9%

Total Subscriber Net Adds

(231,098)

1,418,206

1,701,860

2,007,512

1,658,974

1,500,000

Self-Pay Net Adds

154,275

982,867

1,221,943

1,661,532

1,511,543

1,250,000

Data Source: Conference calls, interviews, presentations and company 10Ks and 10Q.

As I had pointed out in a previous Seeking Alpha article, Sirius initially issued only one subscriber figure for 2014 - total subscribers of 1.25 million - stating that self-pay and total subscribers should converge. Although I suspect the divergence in total subscribers is due to market share changes for Chrysler (which has a one-year trial period) and announced changes for certain Ford packages, the reason is not particularly important. What does matter is that despite so many positives working for Sirius, the rate of growth continues to slow down.

And it's not just the rate of growth that continues to slow down, but the absolute number of self-pay net adds is back to the level it was three years ago. In 2011, new light vehicle sales were only 12.7 million, and the penetration rate was 4% lower. While churn percentage was the same, one key difference was the conversion rate. This is the percentage of new car trials that become (or convert to) self-pay subscribers. The decline from 45% to 41% is quite significant.

If the new car conversion percentage had not declined (and ignoring the lag from trial to self-pay subscriber), we might have expected an extra 468,600 self pay net adds (4% difference in conversion multiplied by 16.5 million new car sales multiplied by 71% penetration rate) in 2014. There are other factors also impacting growth. Back in 2012, the company added more than one million subscribers from used cars, a number that grew to 1.5 million in 2013 and, according to CEO Jim Meyer, is expected exceed the "original full year target of 2 million self-pay additions from the second-owner market this year."

Self-Pay Monthly Churn - The Subscriber Growth Impediment

So, with all this incremental growth in the used car segment and new car sales reaching pre-merger highs, why isn't growth much higher? The answer is mostly due to self-pay monthly churn. Even though churn rate is "only" 1.9%, and quite consistent over the past five years, it is applied to a growing base of self-pay subscribers.

Year-to-date 2014 has averaged 21.5 million self-pay subscribers. Applying a 1.9% monthly churn rate against that figure tells us that 3.7 million subscribers have cancelled so far this year, and that number projects out to a full-year total of more than 5 million. How does the company replace 5 million self-pay subscribers, let alone add subscribers? We have to go back to the new and used car sales.

The Impact Of Car Buyer Demographics

Earlier this year CFO David Frear said:

In 2013, new car buyers converted at about 44% and used car buyers converted at about 34%. We ran about 13 million total trials in 2013, and we expect this number to be over 15 million in 2014. Incremental penetration into more mid and lower end cars may cause a softening of conversion metrics, but with declining SAC per new vehicle, we are more than willing to take this tradeoff (bold emphasis added).

During the recent conference call, Frear again discussed the number of trials:

We had our second-highest-ever quarter for new car trial starts at just under 2.8 million, and used car trial starts set a new record by exceeding 1.3 million. Total trial starts of 4.1 million in the third quarter were the highest in the history of the company, and it certainly gives us confidence in reaching our full year subscriber targets.

It certainly appears that Sirius will run well over 15 million trial starts this year. Critical to the success of the company is getting those trials to convert to self-pay subscribers. And it appears to be getting more difficult all the time. The company is running an extra 2 million trials in 2014 compared to 2013 and may see a quarter million fewer self-pay net adds.

The "softening of conversion metrics" is certainly occurring, and this is taking place despite the new content, less expensive packages and even an increase in retention discounting. The 10-Q notes:

For the three months ended September 30, 2014 and 2013, ARPU was $12.47 and $12.29, respectively. For the nine months ended September 30, 2014 and 2013, ARPU was $12.34 and $12.21, respectively. These increases were driven primarily by the contribution of the U.S. Music Royalty Fee, and the impact of the increase in certain of our subscription rates beginning in January 2014. The positive result was partially offset by growth in subscription discounts offered through our customer acquisition and retention programs, lifetime subscription plans that have reached full revenue recognition, and changes in contracts with an automaker and a rental car company (bold emphasis added).

Note the paltry 1.5% year-over-year increase in ARPU. I see this as an indication that the company is sacrificing revenue per user to grow the number of self-pay subscribers through acquisition and retention discount offers. This isn't surprising considering the penetration into lower-priced new cars. What may be surprising is that the increase in discounts hasn't stopped a rather steep decline in the new car conversion percentage.

And if this is occurring with new cars, what does it suggest will be taking place as the company continues increasing its efforts in the used car space? The used cars with Sirius radios that are currently entering the market are coming from a time period when the penetration was lower and the models were higher-end vehicles. That suggests that as the fleet ages, and the average prices of used cars with Sirius radios declines, they will be purchased by those with ever decreasing incomes. These buyers are less likely to convert and become subscribers.

Will the subscribers that Sirius acquires from lower income demographics also cause an increase in churn? It would seem logical, but churn, like conversions, is a statistic that can be managed with discounting. That can only go so far before it results in ARPU actually declining, and that point is probably not too far away.

Summary

A number of factors - expanded content, strong new car sales, lower priced offerings, an expanding used car program - should be providing tailwinds that would allow Sirius to grow self-pay net adds at a healthy rate in 2014. Instead, the growth in subscribers is expected to be less than 2012 and 2013 and only marginally better than 2011. Compared to last year, ARPU has shown minimal growth. At the same time, Sirius has allowed the conversion rate to decline to 41% from 44% while the churn rate climbed to 1.9% from 1.8%.

Several of the drivers of growth over the past 5 years are unsustainable. New car sales won't be increasing by another 60% from the 10.2 million sold in 2009, or even another 42% from 11.6 million sold in 2010. There won't be another 13,000 car dealers signing on to the used car program. Penetration is unlikely to rise by another 16%. New content may help, but it will be added only at the expense of removing current content. An increasing turnover of used cars may also help the company continue to grow self-pay subscribers, but those potential subscribers will likely be coming from lower income demographics with lower conversion rates. And regardless of whether these additional subscribers churn out of the population at higher rates, it should be remembered that as the population grows, the "low" 1.9% churn rate will be applied to an increasing self-pay population.

It certainly appears to this particular investor that it has become more difficult for Sirius to increase the self-pay subscribers, and it is not at all clear how that trend will be reversed.

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 $4.00 covered calls written against many of my long positions in Sirius XM and have recently sold and bought $3.50 January 2015 covered calls against other positions. I also trade blocks of Sirius XM on a regular basis and may do so at any time. I hold no positions in any of the other companies mentioned in this article.