Why Sirius's Earnings Are Less Impressive Than You Think

Includes: SIRI
by: Ian Bezek

SiriusXm Radio (NASDAQ:SIRI) released what at first glance appeared to be an outstanding earnings report on Tuesday, with earnings of 3 cents a share exceeding nearly everyone's estimates. Investors also were treated to exciting news about the company's upcoming Sirius 2.0 platform. (See earnings call transcript.) Looking further into the numbers, there were more signs for optimism, as tight cost control and shrewd programming acquisition decisions led the company to a 6% reduction in programming and content expenses. This led to a very healthy boost to the company's operating margin.

Certainly one can view Sirius' quarterly results optimistically. Initially, investors shared this view, with the stock trading up strongly in Tuesday's pre-market session, up almost 5% at one point. But it was all downhill from there for Sirius once the market opened, with the stock giving back all its gains and then some. The stock lost nearly 10% of its value from peak to trough during Tuesday's session, as the stock retreated from 2.22 to 2.02 before regaining a few cents at the close. While some of the selloff can be explained by the forceful broader market decline, Sirius' drop cannot be entirely blamed on outside factors.

The truth is that upon taking a deeper look into Sirius' earnings release, we find two big issues. The first of these is that the company rolled a large one-time gain into its headline earnings-per-share number. If you simply adjust Sirius' earnings for a one-time increase in investment income, due to a gain from a acquisition involving a Canadian partner, Sirius' earnings would shrink by nearly half, dropping earnings back into the expected 1 to 2 cent per share range. So, simply, the blowout 3 cent per share earnings result is somewhat of an illusion, and suddenly you are looking at an earnings meet with a revenues miss.

The second problem, the revenue miss, strikes right at the core of the Sirius growth story. Despite encouraging subscriber growth numbers, revenues surprisingly missed analysts' estimates. The company generated a fairly light $744 million, versus expectations of $753 million. Since there were as many subscribers as anticipated, then there is but one explanation for lower than expected revenues: the average Sirius customer is paying a lower subscription rate than anticipated.

This conclusion leads us down a troubling path. Why are more and more Sirius subscribers getting discounted subscriptions? It is, of course, because they are either canceling or threatening to cancel. (I can personally attest to this; I canceled earlier this year, not due to any complaint, but because I moved and was no longer to able to get satellite reception at my new home. Since then, I have received many phone calls and e-mails from the company urging me to come back at very low teaser rates.) As the economy continues to soften, more and more customers will be unable or unwilling to afford their subscriptions and will end up canceling.

Subscriber churn edged up slightly versus the same quarter last year, and the company's ability to convert new customers from their trial subscriptions into paid subscribers fell from 46.7% to 45.2%. We see signs that the economy is starting to make an impact on Sirius, as I projected in my previous article which called for a major slump in Sirius shares.

CEO Mel Karmazin weighed in on the economic concerns, saying:

On our last earnings call, I reported that we were very optimistic about the results that the company will report in 2011. We said that were it not for the uncertainty of the impact that the tragedy in Japan would have on our OEM partners' supply chain and the sluggishness of the overall economy, we would be raising our subscriber growth guidance. Well, the economy remains sluggish, but we are confident that SiriusXM will have a very strong year.

I am not as convinced that the company will have a "very strong year." The company is clearly performing quite well given the competitive and economic headwinds it is facing. It has done an admirable job of cutting costs and growing its margins in a difficult environment. However, the profit growth is coming from a combination of one-time accounting gains and cost cutting. This is not a typical growth-stock recipe; a company can't miss on revenues and convincingly claim to investors that the company's growth remains strong.

Karmazin is banking on a price increase to get the company to the next level; he envisions a 40% EBITDA margin as a sustainable level for his company as it matures. But this projection is much above current levels and relies on pricing growth. With the company already failing to get as much revenue from each user as anticipated, it is smart to count on a price increase to drive revenue growth? Since Sirius' customers are already getting more discounted subscriptions, churning more frequently, and converting from trial to paid subscriptions less frequently, it is unclear whether a price increase can really drive strong revenue growth.

Sirius continues to face strong headwinds to its growth. It is heavily reliant on new car sales to drive subscriber and revenue growth. The economic events in Europe and the US over the past few weeks continue to support the idea that auto sales will be trending downward, rather than up in coming quarters. And with unemployment rising, GDP growth stalling out, and government budget cuts on the way, it is hard to imagine that customers will be flush with new disposable cash with which to buy satellite radio subscriptions. The company continues to offer a great product, and CEO Mel Karmazin is a good business leader. But as the economy enters a recession, it remains impossible to justify paying more than fifty times earnings for a slow-growing company like Sirius. Don't overpay for the Sirius stock only because you like the company's products.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.