Sirius XM: Why $4.00 Is Now More Realistic In 2013

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In a recent article, I talked about why satellite radio giant Sirius XM (NASDAQ: SIRI) was no longer a speculative bet. Although questions remain about Sirius’s profitability and the company’s overall business model, an important bit on uncertainly was put to rest last week.

Sirius XM received a favorable ruling last Friday in its fight against SoundExchange, the organization that collects royalty payments for musicians. A judge ruled that the royalty fees will increase from 8% this year to 9%. However, the most important aspect of the decision was that the fees will then increase by (only) half of a percentage point every year until 2017.

This is important because since Sirius passes these costs on to the subscribers, the degree with which the royalty rates are scheduled to increase makes this more manageable for the company. Any other ruling would have certainly made it very cost prohibitive for Sirius to do this, which would have also hurt the company’s margins.

Although this outcome is not Sirius’ most desirable result, it is one that that the company will certainly not complain about. Earlier this year, Sirius filed an injunction against SoundExchange in an effort to “cut out the middle man.” Sirius wanted to negotiate royalty payments directly with the record companies themselves.

Sirius also contends that the current arrangement was designed to choke off competition, which included Pandora (NYSE: P), iHeart Radio, and various other smaller IP distribution platforms that can benefit more from the royalty reduction. As it stands, this ruling is certain to help Pandora’s profitability woes – although Pandora's stock did not respond as well as shares of Sirius did.

On the news, investors sent Sirius' stock soaring 7% to $2.93, reaching over $3.00 in after-hours trading. This was the company's highest single day share gain since August. Over all, shares of Sirius have gained 60% on the year. But investors now want to know what 2013 will bring.

Today, I think the possibility of the stock hitting $4.00 per share is now more realistic than ever before. At one point there was doubt, but after this recent news the story is much different. What’s more, with the company’s ability to grow subscribers and free cash flow at record levels, Sirius is poised to outperform even the most bullish expectations, as shown in the company’s Q3 results.

During the quarter, self-pay subscribers improved by 2% year-over-year to 371,000 – enough to bring the company’s total to an all-time high of 19 million, which helped bring the number of total pay subscribers to 23.4 million. Likewise, churn, which is the metric that tracks subscriber cancellations, remained steady at 2%.

Although this was one point higher than the year ago quarter, it was offset by a better than expected conversion rate, which came in at 44%. Equally impressive was that Sirius reported net income of $75 million on revenue of $867 million, which represented a year-over-year increase of 14%.

Adjusted EBITDA also jumped to $245 million – representing an annual increase of 24%. As noted, the company logged an impressive performance in free cash flow – registering at $195 million, which was almost a year-over-year improvement of 200%. On the other hand, if there is one concern, it is what Apple (NASDAQ: AAPL) plans to do with its own music streaming service.

Apple has reportedly contacted record labels and laid out its own plans. Though Apple may not be considered an immediate threat to Sirius since Sirius’ primary source of revenue and growth comes from auto sales, it remains an area worth watching.

Bottom Line

With Sirius expecting Q4 adjusted EBITDA and free cash flow to arrive at $900 million and $700 million, respectively, a $4.00 share price is definitely attainable in 2013 if this growth trend continues. What’s more, with auto sales expected to improve going into next year, there is an outside chance that Sirius may exceed its own estimates. It’s a great time to be a fan of satellite radio.

rsaintvilus is long AAPL and has no positions in the other stocks mentioned above. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple. 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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