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Sirius XM Goes 3-for-3

There were three things that I wanted to hear during this morning's Sirius XM Radio (Nasdaq: SIRI  ) conference call.

The quarterly report itself wasn't perfect, but the satellite radio giant did effectively hit on all three points that I was hoping would be addressed.

Let's dive in.

1. "Earnings and subscribers should continue to grow."
Sirius XM's $744.4 million in second-quarter revenue fell short of the $752.6 million that analysts were targeting, but earnings of $0.03 a share blew the $0.01 a share Wall Street was projecting out of the water.

Now it's true that the company's bottom-line results are worthy of an asterisk. Nearly half of its $173.3 million profit came from a one-time pop in investment income, largely the result of cash it received in the completion of its acquisition of its Canadian partner. However, it still would have likely beaten the market there without the windfall.

Head up a few line items higher and operating profits rose at an encouraging 38% clip. In other words, operating margins continue to expand. Shrewd cost controls are the key here. Programming and content expenses have fallen by 6% over the past year despite the larger audience base. There is little reason to expect that to change, driving margins even higher in the coming quarters.

Sirius XM bumped its free cash flow and subscriber targets higher. It now sees free cash flow approaching $400 million this year, up from its earlier $350 million guidance. It also now expects to add 1.6 million net subscribers this year, up from its earlier forecast of 1.4 million net additions.

2. "There will be a rate hike next year, and it will move the needle."
Regulators have cleared the way for Sirius XM to begin raising their basic rates, and CEO Mel Karmazin did reiterate that prices will go up early next year.

Sirius XM agreed to wait until 2012 for the hike as part of a recent settlement.

If you're wondering why the stock opened higher despite the anemic 6% top-line spurt in its latest quarter, there's your answer. Rates will inch higher in two quarters, and pairing that up with the upward guidance in subscribers -- and smart overhead management -- will make this a blazingly more attractive company than it is today.

Karmazin believes a mature Sirius XM can generate EBITDA margins of 40%, and he's a little more than halfway there at this point.

The bigger question here is if listeners will play along.

Subscriber acquisition costs per gross addition have fallen from $59 to $54 over the past year. Programming costs are falling. Perhaps more importantly, average revenue per user is also sliding, partly because of the subscriber retention discounts that Sirius XM offers to customers that it believes it will lose without the markdowns. Sirius XM's conversion rate -- the number of subscribers who become self-paying customers after their free trials run out -- has shrunk from 46.7% to 45.2% over the past year.

Is this really the right time to test its pricing elasticity?

It's clear that many -- if not most -- of Sirius XM's subscribers will be willing to pay more, but the first increase in basic rates for Sirius in its operating history should also have an impact on churn.

This will be a defining moment for the platform, just as Netflix is testing the elasticity of its couch potatoes with its move to bump prices higher on its popular dual plans by as much as 60%.  

3. "Sirius XM 2.0 is going to roll out on time, and it will be a game changer."
We finally got a lot of details on the next generation of satellite radio receivers, and most of it confirms what Sirius XM itself and unconfirmed reports have been saying all along.

  • A pair of Sirius XM 2.0 retail radios will hit stores later this year.
  • The first automaker to install the new receivers will begin rolling them out next year.
  • The new receivers will have access to 25% more channels, and that will largely be filled up by original programming and commercial-free music for Hispanic listeners. Sirius XM claims that it will offer 50% more stations than even Los Angeles' terrestrial offerings for Latinos.
  • Many of the cool features will require online connectivity (e.g., a smartphone in the car or Wi-Fi in the home). These perks will include up to five hours of time-shifting as well as pause, replay, and on-demand options.
  • Personalization will kick in during the first half of next year. In other words, look for customized playlists and music discovery features that will help Sirius XM compete more effectively against Pandora (NYSE: P  ) and other streaming sites.

The personalization feature will be important, because even Apple (Nasdaq: AAPL  ) and (Nasdaq: AMZN  ) have thrown their weight behind cloud-based music streaming in recent weeks. We're no longer talking about fledgling upstarts in this space.

All in all, the future should be an exciting yet challenging place for Sirius XM. The satellite radio star expects to close out the year with $750 million in cash, and it's eyeing share repurchases come next year. But don't read too much into that. There are now 6.8 billion fully diluted shares outstanding, and even inexplicably spending all of its money on a buyback at current prices would only take the share count back to the less than 6.5 billion it was sporting three months ago.

The real drivers here will be the margin-widening potential of next year's hike (if it sticks) and the market-widening upside of Sirius XM 2.0.

Well played, Karmazin. 

What did you think about today's quarterly report? Share your thoughts in the comment box below.

The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of, Netflix, and Apple, as well as creating a bull call spread position in Apple and buying puts in Netflix. 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.

Longtime Fool contributor Rick Munarriz is a subscriber to Sirius since 2004. He does not own shares in any of the stocks in this article, except for Netflix. He is also a member of the Rule Breakers analytical team, seeking out the next great growth stock early in its defiance.

Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 02, 2011, at 2:18 PM, urkllngme wrote:

    en Pandora goes public and people that don't even know it exists now find out, SIRI's new subscriber numbers will tank.

    Add to that the uptake of HD radio that's coming, SIRI will tank.

  • Report this Comment On August 02, 2011, at 4:07 PM, waterinfo wrote:

    A few key points from this mornings conference that deserve note:

    1. Karmizen said "Remember, about 50% of our channels are non-music. Today, we are integrated into every automotive OEM in the U.S. with a very desirable in-dash position, so it is easily available at the touch of a button everywhere." This is huge advantage that SIRI has compared to any other radio source, and especially compared to any IP based streaming service. I just finished a 3930 mile driving trip, and 75% of the time my XM radio was glued to CNBC, MSNBC, CNN, Bloomberg, and even FOX occassionally trying to follow the craziness in Washington with the debt ceiling. Most of the rest of the time I looked for the funny stations for some comic relief. A music streaming service would have done me no good at all.

    2. Karmizen said "over 1,000 General Motors dealers are now able to activate our service in (used) vehicles on their lots, and that service seamlessly transitions to a customer trial after sale. SiriusXM is working with other OEMs to sponsor similar programs for their dealers," This means that milliions of cars will become subscribers as these used cars are sold, without any additional marketing cost from SIRI and without using additional SIRI capital to supply a new subsidized radio receiver.

    3. In answer to a question from an analyst after the formal presentation, it was noted that the modest price increase comming early in 2012 is not likely to change renewal rates and subscriber retention, because the imposition of the royalty fee, which was probably larger than any initial price increase had minimal effect on retention. Even just a 1 dollar increase in the basic rate, which would largely be ignored by the subscribers will result in a quarter of a billion dollars to SIRI's bottom line. In addition, recent events at Netflix demonstrates that SIRI could probably get a way with a much larger increase than $1 per month.

    4. Even modest new features are adding significantly to ARPU. My newest car has XM radio with weather and traffic. After using it for the 3 month free trial, I had to have it, with a $4 per month upcharge on my basic rate. Even a 25% take rate of this feature alone, will add $12 to the average revenue per subscriber (ARPU).

    5. SiriusXM 2.0 is on track, and the impact on acquiring Latino subscribers could be huge. My guess is that the satellite signal can be received in Mexico and other parts of Latin America. This offers additional growth with minimal capital investment.

  • Report this Comment On August 02, 2011, at 4:26 PM, wolfman225 wrote:

    I've had Sirius in my semi for about a year now. I love the service. I listen to a lot of AM radio and signal fade was a major headache. The only major improvement I'd like to see is for there to be a full integration of the channel line-ups.

    As I said, I have a Sirius set. There are a couple channels on XM I'd like to access in order to get specific programming. After numerous calls to "customer service" (oxymoron) about getting access to those channels, the best advice they could offer was for me to spend $200+/- for an additional XM receiver and subscription.

    If Sirius/XM are truly merged as one company, why should it be so difficult to merge all of the channels into a single playlist? Perhaps something like the current cable/satellite packages, they could offer channels a la carte to all subscribers.

  • Report this Comment On August 02, 2011, at 4:45 PM, bottomfisherman wrote:

    Pandora is a joke Rick and no competition to SIRI. They have no way to stop increasing royalties and the CEO himself says they do not know when or if they will ever make a profit. Look for Pandora to be bought either go belly up or bought out in a year or two possibly even by SIRI.

  • Report this Comment On August 02, 2011, at 8:21 PM, ItAintCool wrote:

    urkllngme wrote:

    en Pandora goes public and people that don't even know it exists now find out, SIRI's new subscriber numbers will tank.

    Add to that the uptake of HD radio that's coming, SIRI will tank.

    You must be from the Bizzaro world

    1) Pandora has gone public and it's tanking majorly. The SP has gone from the low $20's to $13 a share. Company's only succeed when you can make money. They have failed to get paid subscriber business and their free business is not gaining enough advertising revenue to make it sustaining. And as their free subscriptions increase, so does their music royalty fees which have been killing their profitability in the first place. SIRI already includes the music royalty fee on top of the subscription price, so they don't have to worry about their profits being cut into.

    2) HD Radio has been around for years and almost nobody is using it. There was no great influx of terrestrial listeners thanks to HD Radio. It's a waste of digital airspace. Much like the digital #.1, #.2 channels on your TV that local affiliates use to broadcast weather reports and infomercials, nobody is watching them. What will HD radio now have to offer that will make it any more interesting than what it has offered in the past?

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