Sirius: More Upside Expected This Year
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A few months ago when I first recommended Sirius (NASDAQ: SIRI), the stock was trading around $2. Today, it is trading around $2.30 per share, a 15% appreciation. There are several things that could drive the stock higher which I will discuss here. First, Sirius has started to sell its radio service to used car dealerships, and this provides another engine for growth. Second, Sirius is conservatively valued even after the recent run in price and its financial conditions are improving. I expect 2012 to be another year of record free cash flow and EBITDA. Third, I believe Sirius offers superior content when compared to smart phone and web-based competitors, and it also runs on the Android, Blackberry and iOS mobile operating systems. Lastly, Sirius is introducing a new satellite program 2.0 which enhances the satellite radio offering to both the auto and retail markets.
Car manufacturers sold 12.8 million new light vehicles in the U.S. in 2011 and major car manufacturers are forecasting a nearly 10% rise in 2012. According to siriusbuzz.com, the new catalyst for Sirius sales in 2012 will be the previously owned vehicle segment and I agree. As a result, this should have a major impact on operating margins since the radio receivers are already installed and the company does not incur these costs when a Sirius XM radio is sold. The reimbursement cost per installed radio is not disclosed, but I suspect it isn’t insignificant as it is part of the second largest expense item on Sirius XM income statement, subscriber acquisition costs, representing 18% of operating expenses (the largest is revenue share and royalties at 20%). The company continues to sign new pre-owned deals for its services and most recently it signed with Toyota, Asbury Automotive, and Chrysler. Sirius radio added about 1.7 million new subscribers in 2011, and it expects to add 1.3 million new subscribers in 2012. I think this figure is very conservative, since there are signs already that the price hike of 11.6% recently introduced is being received better than expected by consumers. With an improving economy and the new and improved content Sirius is offering, targeted demographic group subscriptions could rise five-six percentage points in 2012, bringing this number up to 1.8 million.
With increased customer reach, it looks likely that Sirius valuation will improve from current levels. Sirius has 3.8 billion shares outstanding giving the company a market capitalization of $8.7 billion and an enterprise value of $10.9 billion. Currently, the company has a price to earnings ratio of 33 after earning $0.07 in 2011. I estimate that the company should be able to earn $0.14 per share in 2012 given the price hike it instituted in January (+$0.02 per share), no major satellite expenses (+$0.01 per share), decrease in content expense (+$0.01 per share), deeper penetration in the used-car market (+$0.02 per share), and possible share re-purchase (+$0.01 per share). Assuming a price to earnings ratio of 20, the stock should trade around $2.80, a 21% rise from current levels.
After Sirius and XM merged in 2008, there is very little competition. Most of it comes from Pandora (NYSE: P) (which is still unprofitable) through a free or paid subscription via smart phones, computers and other web enabled devices. With broadband becoming increasingly scarce, I believe that Sirius subscribers have an advantage over other web-based or phone-based radio options. Nobody likes their radio listening to be disturbed by marketing calls. Even more, Sirius offers far better programing when it comes to news, sports and talk-shows. While there is no active competition at this time, it makes sense for Sirius to act preemptively and strengthen its position. It can do so by partnering with one of the ailing mobile device makers Research in Motion (RIMM) or Garmin (GRMN). I am confident that any partnership will benefit Sirius shareholders as the company's CEO, Mel Karmazin, is a seasoned industry executive with a proven track record. There are other areas where Sirius can expand. The exercise market is an area where it can explore growth opportunities as outside sports become more popular and people want to stay informed and entertained while going for a long run or a mountain bike ride.
With an improved service through SiriusXM 2.0 launched at the end of 2011, users are now able to record up to 200 hours of radio station programing as well as stop, pause and resume radio shows or songs. This new platform is still evolving and it will offer more audio and data services in the future creating more value to subscribers.
In conclusion, Sirius stock is up 27% in the first quarter of 2012 but I believe there is still room for the stock price to go up. The debt market certainly thinks that Sirius is a stable company as its non-secured debt is priced at a premium yielding about 7%, lower than the issue rate of about 9%. While there is no guarantee, especially in the technology services market where a new technology may make a business obsolete in a matter of months, I believe this risk is low for Sirius. The company has a proven management and is positioned well to benefit from a rise in auto sales, pre-owned vehicle market penetration, higher subscription prices, and new and enhanced services. While regular radio is on the decline, I believe there are many years of success ahead for Sirius. I would even go so far as to say that Sirius could be called “the Google of radio”.
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