Sirius: New Subscriber High Great For Investors

| About: Sirius XM (SIRI)
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Sirius (NASDAQ:SIRI) has announced results for a reasonably successful first quarter. Total revenue was $804.2 million from $723.84 million on a year-on-year basis and slightly ahead of consensus estimates of $803.83 million. Net income was $107.77 million or $.02 a share against a $78.12 million or $.01 a share in the same quarter of the previous year.

The subscriber base is now an all-time high of 22.3 million and the company expects to add on another 1.5 million this year, which reflects the aggressiveness of their sales tactics and the quality and variety of the commercial-free radio services provided. Revenue for this year is expected to be approximately $2.3 billion with an EBITDA of roughly $875 million and a free cash flow of approximately $700 million.

The other highlights of the first quarter include acceleration in the growth rate of subscribers. Net self-pay subscribers grew by 148% and strong automobile sales lifted the inventory of paid and unpaid trial subscribers to 5.7 million. The monthly churn rate of self-pay subscribers dropped slightly from 2% to 1.9% and the conversion rate for new vehicle buyers was 45%, which was about the same as the previous year. This is the first time that Sirius XM has shown a positive free cash flow of $15 million in the first quarter of any fiscal year.

Sirius is the premier satellite radio company in the United States and broadcasts over 130 satellite radio channels that are free of commercials. Broadcast content includes music, sports, news, entertainment, traffic and so on much of which is drawn from big names in the entertainment world as well as professional sports channels and national news providers. You can access this programming on over 800 devices, which include radios in cars and trucks, mobile phones and smartphones and other products for homes and offices.

I would now like to take a closer look at these first-quarter results. It seems to me that the market did not give enough credit to the company and the stock price remains stable despite the results meeting all expectations. However, it has been my observation that results of this kind do not lift stock prices suddenly but instead serve as a platform for stable and consistent growth in the long term. You get short-term spikes in the stock price only when there are dramatic improvements in revenue or earnings. There are a couple of points to note about subscriber growth. The gross additions are less than what I would like them to be but the growth in the self-pay category is encouraging and augers well for the future. Paid promotional customers constitute the largest pool of potential long-term customers and though the conversion rate is slightly disappointing, the good news is that there are plenty of prospects in the pipeline.

Average Revenue Per User (ARPU) was satisfactory at $11.77 and higher than expectations. Going forward, it would be acceptable if this number was kept at around $12. Subscriber acquisition cost went up from $57 last year to $60 and this is probably due to the lower gross subscriber additions because a higher figure would have lowered the acquisition cost. The higher subsidy costs would seem to suggest that there is not a lot of scope for improvement in this number unless acquisition programs such as the one for used cars boost the gross subscriber additions. The result of the decrease in the churn rate is that subscriber additions are at a higher level than the level last year. Churn rates must be kept at least at current levels if not lower and coordinated with the retention programs so that overall growth is kept at a satisfactory pace.

After a long time, Sirius is generating profits and positive cash flows and it can now be evaluated as an investment candidate on the basis of traditional metrics and conventional techniques. On this basis alone, I have to say that it looks comparable to such high-tech favorites as Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL). It trades at a premium when compared to other radio stocks such as CC Media Holdings (CCMO), Cumulus Media (NASDAQ:CMLS) and even CBS, which has as a substantial radio business. However, when you consider that most analysts believe that earnings will grow at the rate of 20% annually for the next five years, the premium over traditional radio operations may well be justified. Sirius looks downright cheap if you compare it to Pandora (NYSE:P), the Internet radio service that launched an IPO last year and is not expected to earn a profit this year. There is nothing special about the content on Pandora, which now has formidable competition in the United States in the form of the Swedish service Spotify.

On the other hand, Sirius has a business model that seems to be working well even though it has to spend large sums of money on quality popular content such as Martha Stewart and Oprah Winfrey. But it is precisely this content quality that enables the company to attract and retain its substantial subscriber base. Operations such as Pandora rely heavily on advertising revenue which is a far more unreliable source of revenue than subscriptions. Sirius, on the other hand, gets just over 2% of its revenues from advertising and can also be used as a surrogate for investment in the automobile industry.

There are still a number of factors to watch out for, and one of the major considerations is how Liberty Media (LMCA) is going to act in the future. The Liberty investment probably saved the company from bankruptcy and is a preferred stake that will translate into 40% of the equity if converted. Liberty has applied to the Federal Communications Commission for ownership of the licenses that Sirius holds and may well end up acquiring the rest of Sirius at a premium. If you have an existing investment, I would recommend holding until there is some clarity about the future.

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