Is Sirius XM a Buy?

The wicked swings that catapulted Sirius XM Radio (Nasdaq: SIRI) above the $1 mark last month before dragging it back under earlier this month have subsided. The stock has actually traded within a reasonable range in recent days, closing between $0.89 and $0.95 a share through March's trading days.

In other words, all's quiet on the satellite-radio front -- for now.

This won't last, of course. Sirius XM has been a rollercoaster ride for years. The key for investors -- and even speculators -- is to make sure they are on the right side of the next move. Will that be up? Will that be down?

Let's explore the possibilities, starting with pegging a value on the well-worn shares.

Satellites in motion
Valuing firecracker lottery tickets aren't easy, but neophyte investors may not even have a firm handle on what Mr. Market deems that Sirius XM is currently worth.

It's easy to pull up a quote on Yahoo! Finance, see a market cap of $3.6 billion, and assume that this is what it would cost if someone wanted to swallow the company whole.

It just doesn't work that way. For starters, Liberty Capital (Nasdaq: LCAPA) owns a 40% preferred share stake in the company that isn't reflected in the shares outstanding -- and won't be until Sirius XM is squarely in the black. This means that there are actually roughly 6.5 billion shares to factor in the company's value, instead of the 3.9 billion common shares outstanding. This takes us up to approximately $6 billion, but the tab isn't closed yet. Sirius XM has roughly $3 billion in net debt, so its enterprise value is actually closer to $9 billion.

Determining if Sirius XM is a buy or sell at this point requires determining whether or not the company will be worth more or less than $9 billion at some point in the future.

Let's take a close look at the reasons to mark down the stock, and then the reasons to mark it up.

The overvalued argument
Satellite radio's growth has stalled during the recession. There are fewer total subscribers -- and only a handful of more self-pay accounts -- than there were a year ago, with its latest quarter's 6% uptick in revenue coming primarily from higher subscription fees.

Revenue growth isn't pegged to be exactly blazing. Analysts see revenue climbing 12% higher to $2.8 billion this year and rising 7% to nearly $3.0 billion come 2011. The pros see breakeven results this year and a profit of $0.02 a share next year.

These aren't the kind of numbers that would seem to justify a $9 billion price tag. Satellite television leaders DirecTV (NYSE: DTV) and DISH Network (Nasdaq: DISH) trade at trailing enterprise value-to-revenue multiples of 1.8 and 1.1 respectively. That's a far cry from Sirius XM's value, even if we go all the way out to 2011 to lower the multiple to 3.0. Sirius XM may be growing marginally faster than DirecTV and DISH, but the satellite television companies are very profitable. The comparisons get even uglier, naturally, if we move to earnings-based ratios.

Even some bulls may concede that a conventional valuation argument doesn't work in Sirius XM's favor. It's one of the reasons why a reverse split isn't a popular topic, since it would place a greater emphasis on valuation over speculative swings.

The undervalued argument
Buying into Sirius XM's bullish case involves faith that Sirius XM will grow its subscriber base (domestically, and perhaps even internationally), ramp up what the average listener pays, dramatically jack up it margins, and/or expand into new revenue streams.

It doesn't need to win every battle, but it has to be in much better shape on most of the fronts in the future.

Growing its subscriber base is back on track. Sirius XM expects to close out 2010 with 500,000 more subscribers than it started. More new cars are rolling into showrooms with factory-installed Sirius or XM receivers, and the company is reaching out to the used car market. We may get to a point where most of the new activations are simply listeners trading in their old auto receivers.

The international market is more open-ended, though naturally we would be talking about more satellites, burdensome licensing, or the thin moat of digital delivery. I keep thinking about Worldspace. There are whispers of Sirius XM lending a hand in its revival, but it was such a colossal failure the first time around, and dependency on mass transit in emerging markets will continue to make global subscriber growth challenging.

I am more optimistic about the chances to milk more out of existing subscribers. As receivers become more interactive the opportunities improve for better advertising practices and the ability to sell MP3 downloads through Apple (Nasdaq: AAPL). There is so much potential in cyberspace, as Sirius XM's branded channels can evolve into sticky communities that easily lend themselves to high-margin monetization. The penetration rates on traffic navigation, backseat video, and "best of" content remain low.

Margins have improved substantially over the past year, though it remains to be seen if Sirius XM has room for even deeper cost-cutting in the future. It's encouraging to note that all four analysts with 2011 earnings targets out there see Sirius XM turning a profit next year.

The final bullish argument comes in the form of accretive acquisitions and profitable opportunities to diversify. In its present state, Sirius XM isn't likely to earn enough to make the most of its tax loss carryforwards. Gobbling up related companies that are profitable will help, and because of the net operating losses, Sirius XM will be able to outbid most potential buyers.

Finding what to buy won't be easy. Regulators would never dream of letting Sirius XM buy terrestrial radio operators or even Pandora. It may even be a challenge to make a play for Live Nation (NYSE: LYV) as a perfect fit on the music promotion and ticketing front given Sirius XM's front-heavy music stations -- or for Garmin (Nasdaq: GRMN) as an in-car gadgetry giant -- given the tight scrutiny that Sirius XM is operating under.

However, there are and will be plenty of small profitable acquisition targets. If the price is right, it's the ticket to broader profitability and grander share prices for Sirius XM.

So, yes, Sirius XM is a good buy at this point, as long as one has the patience and vision to see it through the long haul.