As most investors in Sirius XM (NASDAQ:SIRI) know, Liberty Media (LMCA) is in the process of trying to take control of Sirius XM. Earlier this week I wrote an article that CEO Mel Karmazin exhibited behavior at the Liberty Media investor conference that was not consistent with someone who was expecting to be the CEO very long. Not only did he arrive late and leave early, but his future at Sirius XM was not discussed. His contract expires at the end of the year, and this conference would have presented an ideal opportunity to discuss the future of the company and Karmazin's part in those plans. Regardless, Karmazin is currently in charge and is very much the public face of the company.
During his presentation at the conference, Karmazin spoke about both the historical performance as well as the future prospects of the company. It should be pointed out that when it comes to near term guidance, Karmazin is noted for his conservative guidance. He has justified his conservative projections because it has been his experience that the stock price gets severely punished when guidance is missed. I have a similar view when it comes to the price of the stock. I'd rather be wrong on the low side and leave some profit on the table than over-pay for the shares. And, of course, my views are often considered bearish despite currently having a long position in Sirius XM.
I have often been accused of looking for the cloud around the silver lining. This is especially true when it comes to subscriber growth. Where others look at Gross Additions, I look at Total Deactivations. Where others look at a 45% conversion rate from paid promotional trials to self-pay subscribers, I look at the 55% that choose not to pay. Where others look at the 1.9% self-pay monthly churn as a very low loss rate, I see one fifth of the subscribers that had been paying for the service choosing not to renew. Others look at the latest 2012 guidance of 1.8 million net additions to the subscriber base as a new record and I look at Total Deactivations in the first six months of the year at 3,616,059, on a pace to easily exceed 7 million for the first time. And, these deactivations are taking place despite an increase in retention discounts. From the most recent Sirius XM 10Q:
For the three months ended June 30, 2012 and 2011, ARPU was $11.97 and $11.53, respectively. For the six months ended June 30, 2012 and 2011, ARPU was $11.87 and $11.53, respectively. These increases were driven primarily by the increase in certain of our subscription rates beginning in January 2012, and an increase in sales of premium services, including Premier packages, data services and streaming, partially offset by an increase in subscriber retention programs, the number of subscribers on promotional plans and a decrease in the contribution from the U.S. Music Royalty Fee due to the December 2010 reduction in the rate from 15.3% to 10.8%.
Old news? Perhaps. The point is that the subscriber metrics the company uses have two sides. At the Liberty Media investor conference earlier this week, Karmazin once again spent a good deal of time discussing subscribers and the metrics used by the company to measure the growth in subscribers. He also introduced a new measurement - household penetration.
While discussing a slide (Number 62) that showed the record numbers of subscribers that the company has achieved - or will achieve - for the third consecutive year, Karmazin wanted to draw special attention to the number of households that Sirius had penetrated.
... the important reason I put this slide up is for you to take a look at the percentage of households that are paying for radio. This isn't the number of subscriptions, because people have multiple subscriptions, but today, only - and I say only - 13% of the 110 million households in the United States have said that they want to pay for radio. We believe that number could be a whole lot bigger.
... We think this number is low... We can't give you, today, how far it's going to go.
He continued by making a comparison to other pay services and said that Sirius XM penetration is not likely to go to the 90% penetration of pay television. Clearly, there is room to penetrate more households - a lot of room. But what else do the numbers tell us? 13% of 110 million households tells us that Sirius is in 14.3 million households. It also tells us that the 23,365,383 subscribers are spread over those 14.3 million households, and that each household has an average of 1.63 subscriptions. This is both good news and bad news.
The good news is that there must be a lot of households with more than one subscription, and it is probably safe to assume that these households represent customers that are more loyal and devoted to the product. And, they should also be less likely to cancel.
The bad news is that even after 10 years, the household penetration is so low. And, many of the 87% of households without a subscription have either had a free trial or actually paid for a subscription, and subsequently made a conscious decision not to pay for the service. Assuming that the trend in the first half of 2012 continues into the second half, more than 7.2 million subscribers will join the ranks of the deactivated this year. During the five year period 2008-2012, a staggering 33 million subscriptions will have been terminated. Some of these deactivations are the result of current subscribers buying a new car, but most are by potential customers deciding that they will not pay for radio.
I had always thought of the Sirius XM service as a product that caters to a niche market. It may be a large niche, but it is still a niche. What I had not realized was how concentrated that its market was.
This is not to suggest that the business model is broken. The increasing EBITDA and rapidly rising free cash flow obviously indicate that critical mass has finally been achieved. But something else should also be obvious. This is not a product that will achieve the 90% penetration of pay TV.
Disclosure: I am 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: I have $3 January 2013 covered calls against most of my Sirius position, as well as some $2 and $2.50 January 2013 and $2.50 December covered calls. I may initiate (or close) a buy stock/sell option position in Sirius, at any time. Also, in addition to long term holdings, I have recently begun day-trading 10,000 share blocks of Sirius XM and may continue to do so. I have no positions, or any plans to open positions in the next 72 hours, in any of the other companies mentioned in this article.