Sirius XM Holdings Inc. (SIRI) Credit Suisse 22nd Annual Technology, Media & Telecom Brokers Conference (Transcript)

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About: Sirius XM Holdings Inc. (SIRI)
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Sirius XM Holdings Inc. (NASDAQ:SIRI) Credit Suisse 22nd Annual Technology, Media & Telecom Conference November 27, 2018 11:30 AM ET

Executives

David Frear - Senior Executive Vice President and CFO

Brian Russo - Credit Suisse AG, Research Division

Analysts

Brian Russo

Good morning, Brian Russo with the Communications Research Team here at Credit Suisse. We're very pleased to have with us David Frear, Senior Executive Vice President and Chief Financial Officer of Sirius XM Satellite Radio. So, thank you for being here, welcome.

David Frear

Thank you, Brian.

Brian Russo

I thought I'd start with - here we are at the years - just about over you know roughly a month left to go. So I thought I'd start with your thoughts on kind of next year. You know what would you say will be the chief execution priorities for the company in 2019?

David Frear

Well, we’ve you know it's funny Greg described it several years ago, one of our management said this he came out, men you guys really grind it out. And so 2019 it will be more of grinding it out, it is tens of millions of transactions that we go through, you know we'll go through over 20 million trials on the new and used car side. And you've got multiple touch points you know throughout that. And I could not a really is grinding it out. It's watching the yield that comes out of each touch and seen what customers are responding to.

Do you need to alter messaging? Do you need to alter formats, alter touch points, and things like that? But the drive will be continue to drive those sort of 40% type new car consumer conversion rates, high 20s for used car, continue to be aggressive on management of churn. We've been really thrilled with the - with what we've done this year in churn.

And then we've got the new channels of distribution what can they turn out to be, right. So, the Amazon you know launch and we've always had a really active marketing program to radios that are active and it’ll be interesting to see how much primary demand we can generate out of the Internet-only service versus how much more engagement from our existing subscribers we can get out of that. So we'll focus on those things as we go into 2019.

Brian Russo

So let's dig a bit into a couple of things that you mentioned. So I wanted to start with auto sales. So 2018 I think is headed for another strong year certainly better than a lot of the expectations were coming in. I think we're heading toward SAR $17 million. What's the feeling among some of your OEM partners, are there indications or concerns that consumer spending trends have changed in any way from what we've seen so far this year?

David Frear

Well it's interesting you mentioned especially with the GM news about - you know, so to coming back on plans. So we think, the automakers I think generally feel pretty good about where the consumer currently is, and - but they know just like we all know the last session that we're talking about the possibility of a recession at some point how do you get ready for it. And you know, you don't want to miss the upside of the continuing boring economy and a strong consumer in the U.S. and - but at the same time we got to be watchful we've been going for a long, long time.

So you know in the GM announcement they’re getting themselves ready. The assortment on the lot really matters, right. If you've got, the bet on sedans for the last few years has been just the wrong bet consumer demand has been sort of away from that. But for what we've seen now, I mean you know we look at Chip forecast for how many chips the Tier 1 partners are calling for. It looks like you know more steady strong auto sales is what we have in in-store.

Brian Russo

So, Jim Meyer recently announced that the long-term penetration of the radios and the new vehicles would increase to 80% a little bit higher than it's been in the past. I remember once it was 75% and 77%, and I remember I think you've explained in the past that some of the OEMs wanted to offer some lower end models to kind of address certain segments of the consumer. But can you help us understand maybe what's changing here, why is the penetration now at 80% versus what we thought it might have been a couple of years ago?

David Frear

Well, we've got a couple of OEMs in the mix who are taking penetration rates up for they were below average in the industry and they're taking them up over the course of the next year. And that's generally you know what it is. We've had OEMs that have been at 90% penetration, OEMs at 80%, OEMs at 60% or 65%. And it's more of those lower penetrated OEMs they’ve decided to move the penetration a little deeper into the product line.

Brian Russo

So, let’s talk about the used vehicle opportunity. I think there's 130 million vehicles on the road now with the SIRI Radio installed, a little bit less than half of all vehicles on the road, and is going to logically grow to 80% over the next decade or so. So, we know the installed base is going to be very large. But maybe you can tell us a little bit about, kind of give the nature of the used vehicle buyer or some of the reasons why you've confidence that you can capture a portion as that installed base of these vehicles grows?

David Frear

Sure. When the used vehicle penetration rates started out in the sort of low- to mid-30s, we were conversion rate, we were stunned right, that our original models assume that you know maybe we get 15% conversion rates out of other used cars. And it’s come down from the low-to-mid 30s into the high 20s.

And I would generally expect just like in the new car business, the conversion rate decline, as the production penetration rate grew. I think the same thing will happen in the used car business. And will it ever get down to the 15% level that we originally thought would be the conversion rate? Maybe not, all right. It looks like there’s stronger demand for the service and it is - it's a long cycle to - for the cars to turn over and for us to get fully represented in the used car business.

I think the transaction penetration rate right now is about just a little under 40%. The used cars, the turnover on any given day are Sirius XM enabled vehicle, vehicles, that 40% is got to go to 80% eventually. And so I think we've got good long term growth characteristics in the used car business.

People do behave differently in that business. So in every single income group that you convert at a lower rate, then a new car buyer. So I mean it does matter which is really $200,000 owners, 150,000, 100,075, 100,050. There’s - it’s a lower conversion rate for that same income group in the used car business and the new car. Is that because it's a perception of a more casual car; second the driveway is just a thriftiness sort of that comes in. Well, I'm not going to spend the money on the new car, I mean, to get the used car.

I'm not sure we really know. We just - it's just the gap has always been sort of - I'm going to call it around 8 points. And I mean, I haven't looked at it recently, but it was that way for every income group and it stayed that way for a while. So it just seems to be an attitude, it’s definitely underneath thing, the financial need thing, the product is not - isn’t very expensive. So anyone who wants to afford it can afford it.

Brian Russo

So let’s talk about the smart speaker deal you mentioned Amazon deal a little bit. You know, you’ve a Bring Us Home campaign and the opportunity to pursue out of the car customers. So I think the Amazon deal you announced is non-exclusive. It’s sort of across promotional partnership with the Alexis smart speakers. I think you said that hundreds of thousands of Sirius customers are already using your product on the Alexa interface. So can you talk to us a little bit about this opportunity to grow subscribers that maybe don’t use the product in the vehicle, but might be interested in the home through to be smart speakers?

David Frear

It’s early days, it’s going to be great to see Amazon, as an extremely powerful distribution partner. And you know we’ll see - we’ve been streaming as you know for a really long time. I think, we started in the fall of 2004. And we always looked at it as been a form of a way of deepening engagement with people that we’ve had already won in the car, right.

And there is an opportunity here to diversify our distribution and to look for people, who are maybe not intending to use in the car at all, and we’ll see how much primary demand, we can generate with that. We’re happy to get whatever we can get. We’re also happy to deepen engagement with our existing subscriber base that we know from just looking at the statistics over the years, as to who stream’s, who doesn’t stream, who buys the spends more by buying the all access product versus spends less and the more engagement you have whether it’s listening time or the amount you’re spending the lower the experience churn rates are .

And so you know there’s an opportunity to win two ways, as we move to this kind of distribution.

Brian Russo

But we should probably think about it, lease that near-term is more is some of that deepens engagement rather than drives may be new customers that for whatever reason didn't used in the vehicle?

David Frear

To be honest I don't know, right. I would think so, but we're, we again are in pretty early days on it. We'll have a good read on it you know probably early next year.

Brian Russo

So let's talk about churn for a minute. I think the second quarter and the third quarter you reported churn that was significantly below the prior year levels. And there were historic lows for the company despite your much higher base of subscribers. So maybe you can talk a little bit about what would you attribute that success to?

David Frear

You know we may be one of these things where we're finding our base, right. You find your base of loyal customers and they're going to stick with you, right. And so you know we've been achieving - the churn has been pretty stable at 1.8% for a long time and it has been dipping down to touch 1.7%.

If you remember the vehicle related churn is increasing all the way along. And so what's really happened over the last few years is that the combination of non-pay in other voluntary churn that those two categories have gone from about 145 basis points a month down to about 120 basis point level. It bounces around a little bit quarter-by-quarter.

And you know honestly we're pretty surprised, right. And so you know when you look at the overall churn rate, the vehicle rate related you would have expected to grow as the cars just age. But I really didn't anticipate you know 20 basis points or so improvement in these other categories and I mean on a big base of subscribers that's a huge increase in that.

Brian Russo

And so, you mentioned its mostly coming from the non-pay or the involuntary. So it's - it's not as if you tightened your credit metrics or what not when you pull customer in, this is just something that’s happening organically?

David Frear

Yes, that's exactly right.

Brian Russo

You think we’ve seen a floor yet to this or you think you can go alone?

David Frear

I would tell you that you should still expect churn in about the 1.8% area. I think that's a good way to think about the business.

Brian Russo

All right, so let's turn to competition which is a question I get a lot. I'm sure you've gotten a lot pretty much since the history of being a public company. So for starters can you help us understand how your content differentiates you from the streaming players?

David Frear

The streaming players today they have been sort of not totally, but almost completely music only services. And there are some that have dabbled in other things the Tune In has a lot of different content, Slacker had different content, Pandora had a couple of - had comedy as well as the music. And now we've seen streaming players begin to get into podcasting.

So they're beginning to get an understanding spoken word has value. For us this wasn't rocket science right. We looked at the biggest audio entertainment platform in North America and in FM radio and what was programming they’ve put up, they’ve put up music, talk, news, sports, traffic and weather.

Okay, right so if 200 million people want to listen to that sounds like we got to copy it do it a little better, take the commercials off the music stations, provide more stations in every market, cover more genres more sports, auto market fans for a lot of people in New York didn’t like this, but I'm a Patriots fan. And so I like to listen to Patriots games when I'm on the road. I don't necessarily want to plug myself in front of the TV all weekend to watch sports.

I'm really just to start - the same universe or Michigan fan. It was tough day the other day. But you know the same thing with the Michigan game, I was traveling. And so I was listening to the broadcast on the app and so it is the diversity of the content that I think really sets us apart.

Brian Russo

You mentioned some of these services are exploring podcasts and kind of realizing the value of the spoken word. Have you seen any of these guys show up when you go to bid for a sports rights or any other kind of non-music rights?

David Frear

Not too much, right, at the end. With sports rights, the leagues are pretty good about selling their rights to as many people as they can. And so our primary interest is the satellite radio rights as well as the ability for our satellite radio subscribers to listen online to have that same experience when they go online. And so, I think that you'll see the leagues always trying to do deals on - for Internet delivered stuff and so there's a deal with Verizon, right, there's a deal, I think it's baseball has with Tune In and they're always looking for ways to sell their rights on other platforms. I would expect them to continue to do so.

And look the leagues are created extracting value from people who just want to use their content. They're very tough.

Brian Russo

Understood. Okay. So a lot of questions I was getting was when Google Play was in the vehicle and we have connected vehicles and this is a topic you have many years of experience, the idea that you know first iPods and then iPhones, connected vehicles are going to somehow road you know the perceived in-car, ease of use advantage, which you know in the bear case I guess is kind of all that stands in the way of you losing customers the streaming services. In your view how important is ease of use in the vehicle as a competitive differentiator for SIRI?

David Frear

Well I think ease of use is important, right. I mean it starts with the content, right. And then but pretty close behind it is ease of use and if your product is hard to use a lot fewer people are going to do it, right. And I mean we know this from experience, because we launched where you had to go to BestBuy or Circuit City or you know RadioShack to you know buy a radio plug it into your cigarette lighter, put an antenna on the car and you know that was definitely not easy.

But we got millions of people to do it, to do it anyway. And it's gone a lot faster with the OEM implementation that's for sure. The thing about the streaming guys in competition is that it's not hard to connect your smartphone to into your car and play it out. And you know if you got an old car you get one of those cigarette lighter adapters with the USB port and if you've got a newer car - a newer car like last 10 years they all have USB port in it.

And so it's pretty easy to play out. And then the user interface is - on the phone is incredibly simple and intuitive to use for all these providers. So, here's the rub that those interfaces what - that app is not going to work as well in the vehicle, because the OEM gets in the middle and the OEM has a perspective on what can display on that screen. And it really doesn't matter if it's going through Android Auto or Apple CarPlay or it’s going through some native integration you do with the OEM. The OEM influences your user interface.

So, what we have going out in car isn't the same thing as what we have going on the smartphone and I'd say it's true with every other provider. So, for us as we look at connected vehicles so that they are - I don't know that in my opinion it's not actually easier to use a streaming service in a connected vehicle. I've done both and I think it's easier to use my smartphone.

And so, with 250 million smartphones on the street in the U.S. all that are really easy to hook up into cars and with 200 million people already streaming, it's a fully scale business and I think ease of uses is conquered there. So, to me what the connected vehicle is doing is it's actually giving us an offensive weapon to expand our content beyond what we can put on the satellite and to be able for the first time ever to interact with subscribers while they're using the product.

Brian Russo

One more on competition then. I have frequently kind of figured these pictures but anecdotes that the younger generation less interested in Sirius XM, they are more interested in streaming. Now, we know your customer base kind of skews towards car buyers, which means above that, which income and you know, typically a little bit older than kids coming out of college. But is there anything you can tell us about maybe the segment of your customer base that’s millennial’s or young generation, how large that is. Are you seeing it increase or decrease or any changes kind of there, and that would be helpful?

David Frear

So, your customer base is always going to reflect your distribution. Right. And, you know, so we were first primarily retailer oriented company 15 years ago and then we moved into a new car-oriented company and then we began - we’re now beginning to get into the used car business.

And so the average subscriber is always going to look like the average person represented in your distribution channels. And millennials if you go back five years ago, we're a significantly smaller force in the auto business than they are today. So, they'll continue to grow in our base of millennial subscribers will continue to grow as their presence, presence and increases in the distribution channels.

They do have different habits that we are watching sort of this digital denizen type view of them that they grew up with streaming and will they stay with streaming, will they adopt radios as a platform. And we'll see how that that goes. They do convert at lower rates than older demos do. We are beginning now to look at how much of that is income sensitivity versus just a change in behavior. I can tell you that the data sets are huge for it yet.

You know, it's an interesting thing that everybody used to talk about interactive music and not so much interactivity anymore right, that is as you look at these streaming services and more and more and more they're headed towards curated experiences that are more of a lean back experience which I think moves the population towards our type of product.

Brian Russo

That's interesting. Couple of minutes left, I wanted to talk about Pandora. So, if all goes as planned, you're in to close on this acquisition in the first quarter. You said you expect to find kind of both revenue and cost synergies but you sort of down played the cost synergies a bit, can get any sense for what cost synergies might be and then perhaps we can get into a kind of cross-promotional opportunities versus maybe potential for cannibalization that sort of thing?

David Frear

I think when it comes down to talking about synergies and the impact of the Pandora transaction that as we move into providing 2019 guidance we'll start to talk more about it than. In the last couple of years, we’ve provided guidance at the conference that coincides with the Consumer Electronics Show. And we’ll see where the transaction is at that point, right. We certainly will be talking more about it then we’ll be talking more about it in our earnings call which will probably be end of January and first week of February and but you know right now we don't have a lot to say, we’re focused on one getting more familiar with the folks of Pandora and then working on the Department of Justice review and SEC comments.

Brian Russo

Got you, okay. Well putting the synergies aside there I suppose just like the industrial logic behind, what the two you can do together that you couldn’t have done separately?

David Frear

Well the thing is - far and away what North American consumers want in audio entertainment is a free service. It is - it just dwarfs everything else, right. So you still have 200 million people listening to AM and FM radio, you’ve got 200 million people streaming and I think but the paid streaming in North America is maybe is it $40 million.

Something, yes and so - so you’ve got 130 million to 150 million people that are actually would prefer not to pay for streaming. And so if they want to free product then for us to really participate in the full stack of audio entertainment we have to be and they - we have to have a free product alternative to get to people. You mentioned 130 million cars on the road, right. And we know we've got 32 million total subscribers and - well 28 million self-pay and another 9 million in trials.

So we have something like - I don't know 30 million, 35 million cars that are active in the service today out of 130 million. Now, some of those are sitting on lots but yet most of the cars are inactive and at the end of the day the only thing that Jim and I are trying to figure out is that we're ultimately going to have 200 million cars on the road with a radio in them, and we want to figure out how to drive the maximum amount of free cash flow out of those 200 million vehicles. And you got to have a free product, if you want to monetize all the vehicles.

Brian Russo

Okay. Well, I'll just squeeze one more and we have a couple of seconds left. Just quickly capital deployment, capital return. I think your commentary was pretty clear on the last earnings call. The Liberty Analyst Day with regard to kind of your commitment to capital return in the third quarter we did see you know the return of the buyback and at the same time you have stated leverage target of 3 times or 4 times, it's above where you are today and when we kind of modeled your future and even - with a significant buyback in place it's kind of hard to get there. Can you just talk about your target leverage how we should think about that as it relates to capital return and brand awareness.

David Frear

Yes. So we put the target leverage in the first place to give sort of guidance to the bond market about what our intentions were in terms of credit quality. The rating agencies of both said that had - sort of leverage a little above for a sustained leverage above for they would consider downgrades. I think when you actually look at our operating statistics, we could carry leverage above 4 and still have financial performance measures that should give us a strong double-B rating.

But for now 4 is, 4 is a good target. It's not a goal to get there, but it is a target that we do want to reassure the bond market that you know we intend to operate as a strong double-B.

Brian Russo

All right. That's all we have time for today. David, thank you very much for being with us.

David Frear

Thank you, Brian.

Question-and-Answer Session

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