Digging Deeper Into Sirius XM's Deal With Auto Nation

| About: Sirius XM (SIRI)
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With the new year came an announcement that Sirius XM Satellite Radio (NASDAQ:SIRI) struck an interesting deal with Auto Nation (NYSE:AN). It is a deal that works well for both companies. Auto Nation gets to provide used car buyers with the benefit of three months of satellite radio, and Sirius XM gets a chance to show off its product in the hope that these car buyers will fall in love with and keep the service. In simple terms, any used car sold by participating Auto Nation dealers, regardless of brand, will get a three month promotional subscription to Sirius XM.

Sirius XM is fairly new at the used car game, and until recently, the numbers simply did not stack up to get too aggressive in that segment of the market. However, last summer the company announced similar deals with GM and Nissan (OTCPK:NSANY) that helped pave the way for the company to announce nearly 540,000 subscribers in Q4.

Before going any further, there are a few points that need to be understood by investors:

  • When the car is sold the consumer gets satellite radio for three months, but is NOT counted in the subscriber numbers of Sirius XM
  • Only after the three month promotional period can the customer be counted as a subscriber, and only IF they elect to become self-paying
  • Cars sold in the current quarter are not eligible to become subscribers until the next quarter.
  • Sirius XM pays a fee to run these promotions, and these fees impact metrics such as EBITDA, and Free Cash Flow (FCF) and Subscriber Acquisition Costs (SAC).
  • People who do not become subscribers after the promotional period are NOT counted in churn (they were never a subscriber), and not counted as a deactivation.

One true benefit to this type of deal for Sirius XM is that it allows an expensive to install factory radio a second (or perhaps even a third) chance at becoming a paying radio. The big cost of these "used car radios" has been previously absorbed in another previous quarter's, perhaps even years ago. That is not to say that these "used car radios" are free of a subscriber acquisition cost. Any fee paid to Auto Nation will be accounted for in the current quarter's SAC numbers. That is not bad though, and the numbers are substantial enough for it to be worthwhile. Consider these metrics:

  • In Q3 of 2011 Auto Nation sold about 45,000 used cars.
  • My research indicates that the "penetration rate" (the number of used cars equipped with satellite radio) is between 40% and 45%.
  • This would imply that of the 45,000 used cars-- somewhere between 18,000 and 20,000 -- would have been eligible for the Sirius XM program.
  • Sirius XM has stated that it is seeing a conversion rate (percentage of promotional subscriptions that convert to self-pay) in the used car segment of "the mid 30's".
  • This would imply that about 19,000 cars would have become non-paid (not counted in the subscriber number) promotional subscribers during that quarter, and that about 6,650 would have converted to full self-paying subscribers the following quarter.

While these numbers may not seem huge, they can begin to tell the story of the used car market. Consider this-- Auto Nation represents a couple of hundred dealerships. The GM deal that Sirius XM inked last summer incorporates over 2,000 dealerships! Thus, in very simple terms, if Auto Nation is delivering almost 7,000 subscribers in a quarter, is it outside the realm of possibility that 2,000 participating dealerships can add 70,000? And we still have not considered the Nissan deal, which likely adds another 500 dealerships to the mix (out of 1,500 dealerships). That would mean the potential from Nissan adds another 17,000 to the mix.

As you can see, the potential of these three deals alone (Auto Nation, GM, and Nissan) is an impressive 94,000 net subscribers each quarter. As Sirius XM signs up more used car dealers, that number will increase.

Given the success of the initial deals (I would estimate that the GM and Nissan deals accounted for 60,000 to 80,000 subscribers in Q4 of 2011), and the fact that Sirius XM announced 3 of them in 2011, I am looking for another 6 to 8 such announcements in 2012. The numbers could grow quickly.

Disclosure: I am long SIRI.

Additional disclosure: I have no position in Auto Nation