Is Sirius XM Still a Speculative Bet?

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I'm willing to confess that when it comes to Sirius XM's (NASDAQ: SIRI) stock performance this year, there has been very little that I have been right about - there's just no way to spin it. I’ve got no place to hide, especially after having suggested that the stock was heading to $1.65. Although in fairness, I can say that shares did hit $1.80, or just 8% off my target, the fact remains I was wrong. Now that I have gotten that off my chest, we can start talking about more important things, such as where the company may be heading next.

Growth Good, Profits Bad

Where Sirius is heading next is not an easy question to answer. By and large, this has had to do with the bulk of investor bearishness. Nobody likes uncertainty - it's the mother of all bear markets. Just look at what concerns over the "fiscal cliff" have done to stocks. In that regard, uncertainty has been Sirius's biggest overhang, whether it's related to its power play with Liberty Media (NASDAQ: STRZA) or the expiring contract of its CEO, Mel Karmazin, the company has had a lot to overcome.

Impressively, in the midst of all of this Sirius has said: So what! The result has been a level of execution that quantifies the company's ability to focus on its mission. Now although Sirius has done a great job of rising above these distractions, there are still questions that it must answer. None more important than, where's the money?

Although growth has been there, profitability is still missing. And in my opinion, that's one of the key components the company needs to find before it can move completely out of speculative territory and turn into a value company. Looking at Sirius's third quarter earnings performance, there are signs that the company is transitioning into a more mature operation. But I worry that Sirius is still too reliant on auto sales to drive growth.

What the Metrics Are Saying

Although the company is making excellent progress in terms of subscribers, as I pointed out recently, growth in Sirius's business model is a double-edged sword since it also chips away at the company's bottom line. For instance, that it reported revenues of $867 million, which represented a year-over-year increase of 14%, was indeed impressive, especially in this macro environment. Likewise, adjusted EBITDA surged 24% to $245 million. But on the other hand, net income dropped 30% year-over-year.

We can go into debates as to why that is and it all might either prove worthwhile or inconsequential. One obvious reason might be that the company used a significant portion of its cash to pay down $107 million worth of debt. This is certainly excellent use of excess capital and I will never fault any company for opting to clean its balance sheet. Nonetheless, there were several operational expenses that caught the attention of investors, which lead me to ask can the business model last?

Some of these included a 5% increase in subscriber acquisition costs. Likewise, sales and marketing expenses grew higher by 10% year-over-year as well as the company's royalty payments, which shot up 21%. Also seeing higher costs were customer service and billings. In other words, although the model is progressing well, there is plenty of room for improvement.

For Sirius, the good news is that customers are proving that they love the service and are willing to pay for it themselves once the promotional trials expire, a number that has now reached 19 million. That's quite an accomplishment considering where Sirius was three years ago when it was on the verge of bankruptcy.

Bottom line

Today, however, the story is much different. With free cash flow growing at record levels and the company looking to extinguish debt each quarter, it's hard to call the stock speculative. But I'm not ready to say that it has reached growth status just yet.

On the other hand, I don't consider the stock expensive either and still see value right here from these levels. Plus, with car sales expected to be strong this fourth quarter, if Sirius can reach the high-end of its guidance, this stock can take off into the new year as it did at this point in 2011. I think Sirius is a good buy right here and a target of $3.10 to $3.20 just might be in the cards at some point in January.

rsaintvilus has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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