Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
2018 was a "good news, bad news" kind of a year for Sirius XM Radio (NASDAQ:SIRI). Will 2019 be better?
On the one hand, yes, Sirius ended up notching its 10th straight year of share-price gains, which is good news for shareholders. On the other hand, though, after soaring nearly 50% in value through July, Sirius stock plummeted in September, in the wake of announcing its intention to absorb internet radio company Pandora (NYSE:P) in a $3.5 billion all-stock deal.
Investors didn't like Sirius' deal to acquire Pandora one bit. After closing north of $7 a share about a week before announcing its purchase, Sirius stock plunged 10% on the day of the announcement, and continued to shed gains for the rest of the year, finally closing out 2018 under $6 a share.
Upgrading Sirius XM
But that's OK, says JPMorgan. Today, it upgraded Sirius XM to overweight and raised its price target from $6 to $7.
It's true that Sirius stock has suffered a decline of 25% from its highs of 2018, explains JPMorgan in a note covered by TheFly.com. However, in the analyst's view, Sirius' acquisition of Pandora could be just the thing to "augment growth in new and existing markets."
Sirius' "results year-to-date" were strong, argues the analyst, and once Sirius has Pandora in its pocket, JPMorgan believes that its strength will "persist" into the new year.
Is JPMorgan right about that? Let's crunch some numbers and find out.
Over the last 12 months, Sirius has grown its earnings substantially. Trailing-12-month earnings at the satellite radio star were $888 million, up from $648 million in 2017. Sales, however, are another matter. In Q3, for example, Sirius' GAAP earnings rose 24%, but the company's sales eked out only a 6% gain.
It gets worse. After growing sales at about 9% annually from 2014 to 2017, the company's total sales suffered a slowdown in growth last year. Compared to 2017 results, the latest trailing-12-month tally of revenue is up less than 5%.
The Pandora effect
Can adding Pandora to the mix help out with that?
On the one hand, the initial addition of revenue from Pandora is sure to help. Adding Pandora's $1.5 billion in trailing revenue to Sirius' $5.7 billion annual revenue stream will give Sirius a 26% shot in the arm, boosting sales substantially. After that one-time event, however, I'm not so certain about JPMorgan's optimism about Sirius' strength "persist[ing]."
You see, if Sirius was growing less strongly than in the past in 2018, Pandora was doing even worse. Sales growth at Pandora averaged 17% in the 2014 to 2017 period, but in 2018, trailing-12-month sales growth has slowed abruptly to just 3.4% more than the company took in in 2017 -- even weaker sales growth than Sirius managed. From that perspective, therefore, it seems to me that Pandora is the weaker partner in this partnership, and not likely to help out Sirius as much as JPMorgan thinks.
Granted, there's still the valuation argument to consider. JPMorgan rightly points out that thanks to its (perhaps ill-considered) decision to buy Pandora, Sirius stock has become 25% cheaper than what it once cost in 2018. But is even that cheaper price a bargain?
After Sirius' summer sell-off, it now has a market cap $25 billion. However, when weighed against the company's $888 million in trailing net income, this still gives Sirius a pretty pricey P/E ratio of 28.2 -- and that's before factoring in debt, of which Sirius carries more than $6.5 billion, net of cash.
The company's P/E ratio when adjusted for net debt: 35.5.
And it gets worse. Over the past 12 months, Pandora racked up GAAP losses of $332 million. Were Sirius to merge its operations with Pandora, as it plans to do, and were Pandora's trailing losses subtracted from Sirius' trailing profit, Sirius would be earning only about $556 million annually going forward, and its debt-adjusted P/E ratio would spike to 56.6.
The upshot for investors
JPMorgan argues that Sirius XM Radio stock will be a stronger performer and show better growth with Pandora added to its stable of brands. In the immediate aftermath of the merger, I do expect to see strong pro forma sales growth at least, but that effect could quickly fade.
Most importantly, the valuation on a combined Sirius-Pandora stock seems, to me, excessive. For this reason, even though JPMorgan may think this stock is a buy today, I do not agree.