Update On Sirius XM Connected Vehicle Business

About: Sirius XM Holdings Inc. (SIRI)
by: Crunching Numbers

CVS sets new quarterly and annual records for subscriber revenue.

CVS revenue remains far below initial expectations.

Q4 may be indicating a slowdown in the rate of growth.

The Sirius XM Holdings' (SIRI) Connected Vehicle Services, or CVS, business unit was purchased from Agero for $530 million just over five years ago. And, ever since then, Sirius has failed to break out the revenue performance of that business. To be clear, in early 2014 CEO Jim Meyer gave out initial expectations that the CVS business would generate

close to $100 million of revenue this year, and we expect to grow this at strong double digit rates over the next many years. We are in the process of fully integrating the CV business into Sirius XM, and its financial results are embedded in our guidance today.

As an early stage growth business, we expect the connected vehicle services product line to contribute at or near breakeven on an EBITDA basis in 2014, but with high variable margins, a relatively low capex profile, and substantial scaling in the business as penetration expands, we see many similarities in the financial profile of connected vehicle services and satellite radio.

... In 2014, we expect connected vehicle services, excluding our existing traffic business, to approach $100 million in revenue. In the course of the next three years, we expect connected vehicle service revenue will double, and will continue to grow at high rates for many years to come.

Let's do some simple arithmetic:

  1. $100 million in 2014 and "In the course of the next three years," [bringing us to 2016], "will double", bringing us to $200 million.
  2. Expected to then grow at "strong double digit" rates over the next many years. How large is a "strong double digit" rate? Certainly, more than 10%. How about 15%?
  3. 10% per year from $200 million in 2016 would put the revenue at $220 million in 2017 and $242 million in 2018.
  4. 15% per year from $200 million in 2016 would put the revenue at $230 million in 2017 and $264 million in 2018.

It took years before the company acknowledged that the growth was less than expected. In May of 2016, CFO David Frear discussed the business at an analyst conference:

...[CVS is] going to have a faster growth rate than satellite radio, but a faster growth rate would mean maybe going from 2% of our revenues to 3 to 4% of our revenues... it's not like it's going to go from 2% to 30%.

......what we're finding is that we're going to get to exactly where we thought before, it's just going to take a little more time because the auto makers are a little slower in their roll-outs. So, what they thought they were going to do two years ago, they're still going to do it, they're just getting to it a couple of years later.

Even those reduced expectations appear to have had a significant miss. While the company still does not separately report the CVS revenue, its quarterly and annual SEC filings and earnings press releases discuss the calculation of Average Revenue Per User, or ARPU. These filings show the ARPU calculations and note that:

ARPU - is derived from total earned subscriber revenue (excluding revenue associated with our connected vehicle services), ...

This allows us to determine the CVS subscriber revenue by subtracting the subscriber revenue used to calculate ARPU from the total subscriber revenue shown in the P&L statements. The following chart shows the subscriber revenue from the CVS business since the end of 2013:

Quarterly CVS Subscriber Revenue (in 000's)
Q1 2014 Q2 2014 Q3 2014 Q4 2014
Current Quarter $18,632 $22,314 $22,421 $24,884
YTD 2014 $40,947 $63,368 $88,252
Q1 2015 Q2 2015 Q3 2015 Q4 2015
$23,089 $24,766 $25,170 $25,428
YTD 2015 $47,855 $73,025 $98,453
Q1 2016 Q2 2016 Q3 2016 Q4 2016
$24,698 $21,862 $21,713 $20,031
YTD 2016 $46,560 $68,273 $88,304
Q1 2017 Q2 2017 Q3 2017 Q4 2017
$20,203 $20,655 $20,644 $22,344
YTD 2017 $40,858 $61,502 $83,846
Q1 2018 Q2 2018 Q3 2018 Q4 2018
$24,835 $26,310 $30,095 $30,181
YTD 2018 $51,145 $81,240 $111,421
Source: Chart by Crunching Numbers from company's quarterly press releases

It should be pointed out that there may also have been other payments for consulting services by the OEMs in connection with the CVS business, although it is not possible to isolate these figures, and it is highly unlikely that they would significantly close the gap. Also, CVS is no longer comprised solely of the revenue from the Agero purchase. Since then the company has also purchased Automatic Labs and Paytollo, although the projections cited by Meyer and Frear were based solely on the Agero purchase. Regardless, the $30.2 million generated in Q4 and the $111.4 million generated for all of 2018 are disappointing.

Those investors looking for a silver lining can take solace in the fact that 2018 set a record for annual CVS subscriber revenues easily exceeding the previous high of $98.5 million achieved in 2015. Furthermore, the $30.2 million set a new quarterly record and was the fifth straight quarter of increasing revenue.

Unfortunately, Q4 was less than $90,000 higher than Q3, the smallest increase in the past 18 months. And, while I expect that 2019 will set another annual revenue record, it will be interesting to see how the quarterly trend evolves. Finally, it is not yet clear how the company will continue to report metrics following the integration of Pandora. If the new data sets issued by the company allow for the continued reporting of the CVS subscriber revenue, I intend to continue providing updates on a quarterly basis.

Buy, Sell or Hold?

I have a very small position that I have held for more than a decade and currently have no plans to sell it. However, I also regularly trade large blocks of shares and will continue to do so, occasionally selling short duration covered calls against these blocks. For those looking for a double-digit return, I believe a relatively low-risk trade would be to buy the shares in the $5.80s and simultaneously sell the June calls with a $6 strike price. As I write this, the stock is at $5.88 and the call is selling for ~$0.34.

The net cost would be:

$5.88 - $0.34 = $5.54

After commissions, the net cost should be ~$5.55 and the expectation would be a sale for $6 at or before the June expiration. The net gain of $0.45 (the $6 strike price less the net cost of $5.55) generates a cash on cash return of:

$0.45 / $5.55 = 8.1%

The 8.1% cash on cash return gives us an annual percentage yield of more than 25% (including the dividend). Are there risks? Sure. If the shares move significantly above $6.30 over the next four months, money would be left on the table. If the shares drop below $5.55 net cost, there could be a capital loss. On the other hand, if the shares do continue to trade below $6, one can sell additional calls at expiration. I consider this to be a conservative trade with minimal downside.

Disclosure: I am/we are long SIRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: As noted in the disclosures, I currently hold several small long term positions and several short term trades of large blocks. I expect to sell covered calls against two of these positions and will buy and sell shares at any time. I do not sell Sirius shares short.