Sirius XM Already Gave You an Answer

There's never a shortage of speculation when it comes to Sirius XM Radio (Nasdaq: SIRI  ) as an investment. Now there seems to be a debate as to what CEO Mel Karmazin meant when he told Jim Cramer last week that the impact of a January price hike on the satellite radio operator's subscriber base has been "very modest" so far.

Is that good? Is that bad?

Sirius XM's decision to increase its monthly rates by 12% in January wasn't inconsequential. The media giant wasn't allowed to move its primary rate higher for three years as a condition to having the merger between Sirius and XM approved by regulators. Sirius itself had been at $12.95 a month since its inception a little more than a decade ago, though it has tacked on new fees for Internet listening and increased the rates on family plans in recent years.

The 12% increase seems fair on the surface. Check your cable bill. Surely it has gone up by more than 12% over the past three years -- unless you've smartened up and switched providers or called up to negotiate a lower rate.

However, programming and content costs have actually declined over the past year -- unlike cable and satellite television companies that need to pay more for their content with every passing year.

Not like Netflix
Netflix (Nasdaq: NFLX  ) was raked over the coals after its new pricing structure that increased some rates by as much as 60% kicked in last summer. The video specialist paid the price in the form of huge defections during the third quarter. Streaming subscriptions began climbing again during the fourth quarter, though DVD plan customers continue to bolt.

Comparing a meager 12% increase to a 60% spike seems outrageous, but at least Netflix could point to the skyrocketing streaming costs to justify the new pricing. Will subscribers let Sirius XM pull off the price increase?

"I'm trying to get my arms around why you should be worth $15 billion and not $7 billion or $6 billion like Netflix," Cramer pointed out during a critical moment in last week's Mad Money segment.

"I don't make the valuation," Karmazin responded relative to the disparity. Rightfully so. It's not Karmazin's fault that Sirius XM is worth more than twice what Netflix is -- and actually more than three times as much if we introduce net debt to arrive at the more accurate enterprise value metric. Mr. Market's the one to ask about that.

However, Karmazin did speak up about the January price increase.

"Our consumers have been really loyal and they really love our product," he said. "The reaction has been very modest. Very modest. So, you know, we feel very good about, you know, the subscriber growth in light of the fact that we put in a price increase."

Very modest? What does that mean? Are folks not leaving at all, or is the number of defections being offset by the higher revenue?

Thankfully, we don't really have to guess. Karmazin gave us a meatier response just last month.

As the world churns
There is really no such thing as an inconsequential price increase. If a company had pricing elasticity to charge more -- it would.

However, Sirius pretty much spelled out the impact of January's increase during February's quarterly conference call.

"We expect churn to be up modestly this year, probably in the 2.1% range," Karmazin said at the time. "Without the price increase, we would be providing self-pay churn guidance consistent with past year's of 1.9%."

Not only is the word "modest" used both time, but he's actually giving investors the answer.

What does the 0.2% difference in the monthly churn rate imply? Given Sirius XM's 21.9 million subscribers we're talking about a little more than 40,000 subscribers leaving -- on average -- in any given month because of the price increase. Over the course of 2012 we're looking at roughly 500,000 subscribers leaving because of the increase.

Is that a lot? Is that a fair trade-off?

Well, it is. Investors may have been disappointed with last month's subscriber guidance -- hearing that Sirius XM is targeting 1.3 million net additions this year after tacking on 1.7 million more members last year -- but Karmazin is saying that it would have probably added slightly more than last year's 1.7 million if it wasn't for the January rate increase that will take roughly 18 months to work its way through most of its accounts.

In case you're wondering, it is worth it.

Having premium subscribers willing to pay more for satellite radio will make the platform more attractive to advertisers on the channels that do play commercials. Sirius XM's guidance also justifies the strategy. In calling for free cash flow of $700 million -- a huge 75% boost over 2011 and a headier pace than its projected 10% top-line growth -- Sirius XM is telling you that it's placing more emphasis on generating more real money that it can use than some fancy subscriber or revenue milestone.

This is a business, and Karmazin is growing it the right way.

Running of the bulls
I remain bullish on Sirius XM's future. It should come as no surprise that I'm promoting the CAPScall initiative for accountability by reiterating my bullish call on Sirius XM for Motley Fool CAPS.

XM Satellite Radio was a Rule Breakers recommendation before the Sirius XM merger. It's now gone from the scorecard, but if you want to discover the newsletter service's next rule-breaking multibagger, a free report reveals all.

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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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 March 16, 2012, at 2:18 PM, doubting wrote:

    Rick,

    I listened to the interview several times to make sure I do not miss any nuances that Mel tried to convey. Mel is not Churchill and does not always come across as clear as he would like to. On top of that, he is viscerally afraid of unnecessary shareholder lawsuits.

    I translate "very modest" differently than you. I also use different reference points. At the end of the day, serious investors and analysts pay attention to quarterly sub growth, its cost (SAC) and revenue per user (ARPU). These are my reference points. To me, "very modest" price increase impact actually means a 10 to 15%% reduction in subs in Q1 that may be compensated by much higher SAAR in 2012 than in 2011. This means that in Q1, 2012 siri will most likely produce the same or slightly lower sub adds as in Q1, 2011, namely, between 340K-370K. SAC may turn out somewhat higher but ARPU will also be better if not much better due to the price increase. SAC growth may actually be counter balanced by more contributions from used car market where costs may be next to nothing. Mel is amazingly strong at managing costs and we should not expect any spikes.

    Comparing Sirius XM and Netflix is comparing apples and oranges. Sirius has a ton of advantages over nflx due to its significant content acquisition strength. As Mel put it, there is only one company you can sit down to negotiate. I would add that there are NO radio companies with such purchasing power. Recent treatment of nflx by liberty media showed a fundamental weakness in nflx's business model. Also, content in TV and video is very expensive, highly desirable and is created by heavy hitters that can easily dictate to companies like nflx. Name me companies that could stand in line for expensive radio content. I know of one - Sirius XM.

    Concerning reduction is siri's programming and content acquisition costs, its inevitability was to be expected. First, original contracts of the two companies were rip offs; second, siri is simply fixing the problems of the past and taking advantage of its current strength. Good for them!!! We will see not only better financials but also better and more diversified content for less!!! Why not!!!

    To summarize, Mel's "very modest" price increase impact, in my view, is factually modest and better than he guided. Q1, 2012 will most likely feature numbers that we have never seen before with revenues over $800M, EBIDTA in the vicinity of $150M and fcf about $120M. This is the growth trend that the company will be enjoying for at least this decade with margins over 40%, as Mel promised.

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