The Biggest Market Opportunity: Sirius XM?

During any given week, Sirius XM Radio (NASDAQ:SIRI) is among the most actively traded stocks in the country on a share volume basis.

Its allure is obvious. Satellite-radio receivers are common features in new cars, and Sirius XM has cornered the market with last year's merger. The stock also trades for less than a buck, and it's been a real scorcher this year, giving the investment more than mere speculative buzz.

The company has suffered two sequential quarters of subscription declines, but few investors expect that downtrend to continue if the economy -- especially the automotive sector -- improves. Either way, Sirius XM still caters to 18.4 million subscribers. That's an impressive number of people paying for a medium that was completely free a decade ago.

In assessing Sirius XM's market opportunity, it's important to assess its potential downsides and upsides. Let's tackle the thorny upside first.

The ceiling
Sirius XM didn't have to sell its soul to the devil to survive February's near-death experience, but it did hand over 40% of the company to Liberty Capital (NASDAQ:LCAPA). Those 12.5 million preferred shares issued can be converted to nearly 2.6 billion shares. When you tack that on to the 3.9 billion shares outstanding at the end of the second quarter, you get 6.5 billion shares.

So what's the realistic upside here? Optimists may like to offer up a lofty price -- like $10 -- but then they find the "on" button on their calculators. At the $10 price point, Sirius XM would command a $65 billion market cap. That's before you tack on any more shares the company might print over the coming years, not to mention today's roughly $3 billion in debt.

Wishing that Sirius XM will one day be worth $65 billion in market cap -- or $68 billion in enterprise value -- doesn't make it so.

DirecTV (NYSE:DTV) is a fair proxy. It's profitable, as Sirius XM should be by the end of next year, and it has 24.2 million satellite television subscribers, which could be a realistic peak user base for satellite radio under rosier circumstances. However, DirecTV commands a market cap of just $26 billion -- or $29 billion in enterprise value, once you tack on its long-term debt.

This would make a sticker price of $5 the next feasible perch for each share of Sirius XM, but there's another humbling distinction here. The average DirecTV user is paying $83.16 a month, compared to a mere $10.66 per user for Sirius XM.

I believe Sirius XM averages will inch higher. The company recently introduced music royalties and online streaming fees. The Apple (NASDAQ:AAPL) iPhone app will encourage smartphone owners to pay $3 more a month over their regular subscriptions, and backseat video and GPS offerings will also bump up the company's revenue. However, it's hard to fathom average revenue per user topping $20 a month for premium radio. Since that's less than a quarter of DirecTV's take, it whittles down the company's stock ceiling to a sobering $1.25 a share.

The outlook does get better, though. DirecTV has to pay for its channels, while Sirius XM owns a lot of its content and has a say on the rest. As its platform evolves, it will be able to sell more digital downloads, and even sponsored products. Future models of interactive receivers should allow listeners to engage, vote, and shop. None of that will make Sirius XM an aural Amazon.com (NASDAQ:AMZN), but the promise should be enough to justify jacking up the target price to $1.75 or $2 in a few years -- well ahead of where the stock finds itself today.

The floor
The stock is unlikely to return to the nickel-a-share price at which it bottomed out back in February. Its subscriber base may have waned -- during the same six months that leisure subscription services DirecTV and Netflix (NASDAQ:NFLX) grew -- but that should stabilize with the improving auto market. Then again, other entertainment services, including DISH Network (NASDAQ:DISH), have shed subscribers.

Sirius XM has also been revising its adjusted operating income targets higher, making it more than likely to cover its debt interest and other obligations.

So where's the bottom? The out-of-favor yet profitable DISH is trading at 0.7 times trailing sales, a little more than half of DirecTV's multiple. Analysts see Sirius XM generating $2.5 billion in revenue this year, and $2.7 billion next year. If we apply the DISH multiple -- both companies have similar debt loads, so we're basing this on market cap -- Sirius XM would be valued at $0.30 a share.

Since Sirius XM has healthier catalysts than DISH, this doesn't mean that Sirius XM should be valued at $0.30 a share. But it's a reasonable bottom, as long as Sirius XM remains on its path toward generating positive cash flow.

In conclusion
Is Sirius XM's the market's biggest opportunity? No. The floor is closer than bears suspect, and the ceiling isn't as high as bulls would expect. Trading will remain volatile on a daily basis, but as a result of the bloated share count, the stock is unlikely to shed half of its value -- or double over the next year.

Sirius XM is safer -- yet unfortunately, more upside-constrained -- than Mr. Market thinks.

I've shown you my calculations. Where do you peg Sirius XM's upside and downside potential? Let me know in the comments area below.