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Sirius XM: Why $5.00 Might Be In the Cards for 2013

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

One of the most difficult aspects of investing is trying to figure out where the lines are drawn between good companies and bad ones. Every once in a while the line becomes clear. However, just when you think you have company pegged correctly, you realize that you’ve been wrong all along. This is where I’ve arrived with satellite radio giant Sirius XM (NASDAQ: SIRI).

Though I have spent most of this year beating up on the stock, my constant need to “want to be right” served as my biggest pitfall. The good news is it’s not too late. For as uncertain was the company’s future was just a few months ago, in a span of 5 days, Sirius has been able to remove clouds of doubt and have made a case for why it just might be one of the best value plays on the market today.

On Monday, I made a case for why Sirius might reach $4.00 in 2013. After the company’s announcement this morning, appointing Jim Meyer as interim CEO to replace Mel Karmazin, I’m beginning to think that $4.00 just might have been a bit too conservative. In a moment, I’ll explain why.

For now, this announcement brings clarity while offering a hint of where the company’s long-term thinking may be. Meyer, who is currently president of sales and operations at Sirius is widely regarded within the organization for his strong management skills and attention to detail.

The company is looking for as easy of a transition as possible. And although Sirius has placed the “interim” label with this move, there is a 70- 85% chance that this decision can become permanent. Meyer emerged as a strong candidate to replace Karmazin because of his hands-on involvement with operations and has been credited for the company’s strong performance over the past several years. In accepting the new role, Jim Meyer had this to say:

"I'm honored to lead SiriusXM during this important time for our Company. SiriusXM is a great business and I look forward to working with our talented management team to continue to deliver the best content and service to our subscribers, while enhancing value to our shareholders."

Karmazin who has been with the company since 2004 will leave immediately and forfeit his seat on the board. He leaves behind a legacy which includes being the architect of the merger with (then) rival XM Satellite Radio. He informed the company over the summer that he would not be renewing his contract which expires at the end of the year – presumably because of Liberty Media’s (NASDAQ: STRZA) inevitable takeover.

For Sirius, this morning’s announcement followed another obstacle that was cleared last Friday after the company received a favorable ruling in its fight against SoundExchange, the organization that collects royalty payments for musicians. It was determined 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 Sirius. 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. But this was just one example of the hurdles that are beginning to come down.

Sirius has been able to overcome chronic noise from writers like me who suggest that its downfall will be the result of increased competition from the likes of Pandora (NYSE: P) and other IP platforms such as iHeart Radio and Spotify. We were wrongBut more impressive has been how Sirius has been able to overcome the threat of Apple (NASDAQ: AAPL), which is expected to announce its entry into the realm of music streaming. Investors became concerned that Apple’s creation of the “smartcar” would signal the end of Sirius. But Sirius was unfazed.

Despite all of these distractions, the company has been a model of execution. The stock has soared 66% year-to-date from $1.79 last December to reaching as high as $3.01 on Tuesday. Another 66% would place the stock at $5.00 per share. Is that possible? But even if Sirius were to appreciate by (only) 50% it would still mean the stock would have reached $4.50. This is certainly a possibility - particularly with auto sales expected to continue to grow.

Couple this 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 which, 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%. 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%.

Bottom Line

It is remarkable how Sirius has been able to erase so much doubt in a market that remains so uncertain. However, it remains to be seen how Apple’s streaming model might impact Sirius’s ability to grow revenue. But then again, these are the same questions that the company has been answering all year.

At current levels, the stock remains a bargain - if for no other reason than the fact that Liberty Media has to buy more to gain majority ownership. I’m maintaining my near-term $3.30 price target for the February quarter and expect the shares to appreciate north of $4.00 by this time next year. I can’t believe I’m thinking $5.00.  With quarterly adjusted EBITDA and free cash flow growth – it’s possible. 

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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