Sirius: An Undervalued Stock for an Improving Economy

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About 55 million shares of Sirius (NASDAQ: SIRI) trade on a single trading day. This represents 1.5% of the 3.8 billion shares Sirius has outstanding. For comparison, 0.6% of Microsoft outstanding shares trade daily. Brokers and day traders love Sirius because of its short-term price fluctuations (assuming there are 240 trading days a year and an average share costs $0.01 to trade, trading in Sirius XM shares generates roughly $132,000,000 in trading revenue per year for the brokerage firms). I think that Sirius also makes a good long-term investment as it is becoming an increasingly popular option for new cars sold in the U.S. More recently, the company started to expand in the used car market and to offer improved services. In addition, compared to Netflix (NASDAQ: NFLX) and Pandora (NYSE: P), Sirius appears to be undervalued on a number of metrics. Finally, Sirius is partially owned by Liberty Media (NASDAQ: STRZA) and recently the company tried unsuccessfully to gain control of Sirius. In my opinion, Liberty Media is not a company that gives up easily and a deal at a significant premium to its current valuation could be in the works. A deal at a premium and fair price would avoid a prolonged fight with shareholders and the board of directors, which is usually very costly to both companies.

In the beginning of April, the car-industry leading information source, Automotive News, announced that light car sales increased by 13% compared to March of 2011, or 1.4 million light vehicles were sold. The uptick in auto sales is very good news for Sirius as the company's radios are pre-installed in an estimated 60% of the cars sold in the U.S. As the economy continues to improve, I expect people to buy more new cars and to sign up for Sirius XM satellite radio.

With baby-boomers retiring and traveling around the country, demand for in-car entertainment is increasing and Sirius offers the best programming services for the retiring baby-boomers as well as younger generations. For example, in the first half of April, Sirius announced several new shows and programming including The Women on The Web, the official internet radio partner of MLB.com, a live town hall event with Cardinal Timothy Dolan, new parents radio series, streaming of NHL games, and a special concert by the Beach Boys. Last but not least, Sirius is targeting the increasing share of the Latin American population with ¡Inspírate!

Sirius is able to contract programming at attractive prices. During 2011, programming expense represented 10.4% of revenues or $81.4 million. For 2012, programming expenses are expected to decrease. In addition, recently the court threw out Howard Stern's suit against Sirius. The former DJ was suing the company for $300 million. If Howard Stern had won, this would have been a major defeat for Sirius and would have cost about $0.08 per share.

While Sirius XM's penetration and programming is superior, it is also improving sales in used cars and offering new services. Most recently, Sirius added Toyota, Asbury Automotive and Chrysler pre-owned dealerships as part of its distribution network. Also, at the end of 2011, Sirius launched an improved service, Sirius XM 2.0. This additional service provides more value and flexibility compared to regular radio, as it allows customers to record programming as well as stop, pause and resume radio shows or songs. The platform is expected to offer more audio and data services in the coming months.

I think that what makes the company a compelling investment compared to its peers is its valuation. Netflix and Pandora provide content but have more competition. During 2011, revenue per employee for Pandora was $517,000 and for Netflix it was $1,365,000. These are both significantly lower than Sirius' revenue per employee of $1,975,000. In terms of profitability, the net profit margin of Sirius is also superior at 14.2% compared to 7.1% and (5.9)% for Netflix and Pandora, respectively. While Sirius is a more efficient and profitable company, its valuation based on forward looking price to earnings is more attractive. It is 20.4 for Sirius, 43.3 for Netflix, and 273 for Pandora. Comparisons for 2012 are difficult to make as both Pandora and Netflix are expected to lose money in 2012.

Currently, Sirius has a market capitalization of $8.5 billion and an enterprise value of $10.65 billion as the company has slightly more than $3 billion in long-term debt. Liberty Media owns 40% of the shares and the media reported recently that it is trying to take control over Sirius. Liberty Media is led by John Malone, who is a well-known media executive and deal-maker. Liberty Media has $2.5 billion in cash so the company should be able to borrow and take out Sirius even if it loses the current fight over Sirius at the FCC. In any event, Liberty Media owns 40% of Sirius and taking control of the company should be at a significant premium to Sirius' current stock price.

In conclusion, I think that Sirius is in a sweet spot being courted by Liberty Media and at the same time increasing sales and profitability. The demand for in-car radio entertainment is rising and Sirius is in 60% of each new car sold in the U.S. Also, the company is making steady progress into new sales channels such as used-cars and at home radios. At current valuation levels, Sirius trades below its peers. I believe the value in the stock should be realized once the current economic and political uncertainties are over (after the next election cycle).


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