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Good News and Bad News at Sirius XM

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Satellite radio continues to grow, defying the skeptics that feel that the booming popularity of free streaming will eat into Sirius XM Radio's (Nasdaq: SIRI  ) audience in this dicey economy.

The only game in town when it comes to satellite radio generated mixed third-quarter results this morning.

We've got bad news. We've got good news. Let's start with the pessimistic points so we can counter that with some optimistic swagger.

The bad news
Revenue and subscribers aren't growing as quickly as Wall Street would like. Revenue climbed 6% to $762.6 million, just shy of the $764.2 million that the pros were targeting. Sirius XM added 334,000 more subscribers than it lost during the past three months, but analysts were banking on as many as 400,000 net additions.

Those sticking around are paying less on average, as Sirius XM's average revenue per subscriber has fallen from $11.81 to $11.66 over the past year. Lowering its music royalty fee 10 months ago is eating into how much the company can milk out of its listeners, though the company is also blaming the subscription discounts that it's down to offering to keep subscribers around. The need for markdowns in attracting new listeners and retaining old ones is problematic, especially when Sirius XM is just two months away from a well-publicized rate hike.

Another thing that doesn't bode well as we head into January's base rate increase -- going from $12.95 a month to $14.49 a month -- is that conversion rates continue to shrink. Just 44.4% of new car buyers with satellite receivers are paying to keep their subscriptions going once their free trials end, down sharply from the 48.1% rate during last year's third quarter.

Sirius XM isn't worried. It blames the product mix. During this morning's conference call, CEO Mel Karmazin explained that buyers of particular car models are converting at the same historical rates. Automakers just happen to be selling more of the cars that haven't been conducive to premium radio in the past.

The good news
Sirius XM is faring well once you get past the sluggish top line. Free cash flow and adjusted EBITDA are rising much faster than revenue, fueled by smart cost containment as Sirius XM continues to realize the synergies of the 2008 completed merger between Sirius and XM as well as the economies of scale. Sirius XM's $0.02-a-share profit for the quarter was double what analysts were forecasting.

A decade ago, few would have expected there to be 21.3 million premium radio subscribers -- with more than 17.5 million of them as self-pay accounts.

Net advertising revenue is up 18% over the past year, and that makes sense. If you were an advertiser, wouldn't you prefer to reach listeners who are willing to pay for audio content? Terrestrial radio may have the benefit of local segmentation and Pandora (NYSE: P  ) offers pinpoint consumer targeting, but the ads are ultimately reaching out to freeloaders. AM and FM listeners may not have a choice if they don't have satellite receivers, but free ad-based Pandora customers do -- and the fact that they choose ads makes them less attractive to marketers.

Another positive in this morning's report is that subscriber acquisition costs continue to fall, dropping from $59 per gross addition to $55 over the past year.

The uncertain future
Karmazin points out how some premium subscriber services didn't grow during the same three months. Satellite television giants DIRECTV (NYSE: DTV  ) and DISH Network (Nasdaq: DISH  ) report in the coming days, so this was clearly a jab at Netflix (Nasdaq: NFLX  ) .

Karmazin better be careful about throwing stones at Qwikster houses. We still don't know how consumers will take to the 12% rate hike he will begin to roll out in two months. Karmazin argues that it's just $0.05 more a day, but Netflix probably thought that $0.20 more a day wouldn't be a deal breaker for couch potatoes -- and folks spend far more time at home than they do in their cars.

The satellite radio star can't argue that the increase is necessary, because programming and content costs have actually fallen 10% over the past year. He also can't point to Sirius XM 2.0 as the reason for the hike, because the vast majority of today's subscribers won't have access to the additional channels and features for years until they upgrade their receivers.

Sirius XM's calm chieftain remains reassuring through all of this. He's not hearing any resentment or noise related to next year's modest rate increase. He also is sticking to his guidance for 1.6 million net subscribers for all of 2011. In other words, 334,000 may seem light now, but he doesn't see a problem closing out the current quarter with roughly 440,000 more net additions to hit his mark.

Save for an ugly period in late 2008 and early 2009 where Karmazin had to backpedal off his initial guidance, Karmazin has earned the right to be trusted. Unless the economy is teetering on a flimsy cliff again, it's smarter to bet on Karmazin than against him.

If you want to see how Sirius XM stands up to the stream teams, add Sirius XM Radio to My Watchlist.

Motley Fool newsletter services have recommended buying shares of 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 calls them as he sees them. He does not own shares in any of the stocks in this story, except for Netflix. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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  • Report this Comment On November 03, 2011, at 8:05 AM, kmacattack wrote:

    There are a multitude of reasons why I love SIRI. I've been out of the stock for about 90 days only because I placed a stop order which locked in a 70 percent profit in about 18 months for me. Mel's explanation as to the conversion rates makes perfect sense. A bottom end Kia buyer, for example, would not be a typical target customer for SIRI. A Honda Accord or Ford Fusion buyer, by contrast, would likely be a "buy and hold" customer who would not only enjoy the SIRI service, but would likely never discontinue it. With the American auto fleet at an all time high 10 years old average, there is a huge pent up demand for new and newer model used cars, many of which will feature SIRI receivers as standard equipment. Siri has been agressiively marketing as of late to the used car dealer market, which should activate millions of more currently inactive radio inventory. The content of SIRI is absolutely the best available, and again, the customer who buys a car costing $20,000 or more is the customer who will continue to pay for SIRI once the "free trial" period is over. Siri has the capacity to "skin a cat" in so many ways, with the ability to aggressively market in foreign markets, such as the Asian continent nations China, India, Pakistan, etc. which all have emerging middle classes and in which millions of new cars are going to be sold. The Hispanic market in the US is another huge market, and 2.0 gives SIRI additional bandwidth to provide Hispanic language channels. Siri could offer a lower cost option with a limited amount of tasteful commercials, and with a limited program package at a price point of $5.95 for example. You wouldn't get Stern, or the best music channels, no NFL network, etc. buy would have far superior programming to Pandora or terrestrial radio stations. The price increase was a brilliant move by Mel. It's enough to generate another $400 million per year or so, but not so much as to make any loyal SIRI listeners to leave. Siri could offer subscribers the old price, for example, if they were willing to pay for a year's service in advance. This $400 million will enable SIRI to quickly pay off their debt which was a crushing figure 2 1/2 years ago. With every new subscriber, profit margins increase, and SIRI's profit margins are substantial. I'm not so concerned about the rate of growth in subscriptions as the increased profit margins. I would far rather that SIRI report vastly improved cash flow instead of 15 percent growth rate, for example, with lower profit margins. Volume with no profit doesn't impress me as an investor. I think Siri is a buy at current levels, and I'm ready to pull the trigger and buy back in. I think a $3.00 target by mid year 2012 is very possible, and maybe $4 by year end. SIRI moved "over the hump" when they surpassed about 16 million subscribers, and will continue to make ever increasing profit margins which will allow them to retire all their past debt. There is nothing to compare to SIRI, and I'm jumping back in with both feet.

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