Sirius XM Radio (Nasdaq: SIRI) may not be as expensive as you think.
Citigroup analyst Jason Bazinet is raising his price target on the satellite radio service provider, while also making an argument that Sirius XM can beat the market's historical returns on valuation alone.
His move to boost his price target from $2.20 to $2.50 while reiterating a bullish rating isn't satellite-shattering news. There are several analysts already perched way higher. Barrington Research's James Goss has a target price of $3 on the stock. Earlier this month, Maxim Group's John Tinker established a $3.20 target for 2013.
Bazinet concedes that Sirius XM's equity is being valued at a "lofty" 28 times trailing free cash flow, but the scalable nature of this model makes this a far more attractive argument if we trade our rearview mirrors for forward-looking windshields.
Back to the future
Sirius XM's robust guidance calls for free cash flow to grow from $416 million in 2011 to $700 million in 2012. How can a company targeting revenue to climb by a mere 10% in the year ahead be brazen enough to point to a 68% improvement in free cash flow?
Well, history is on Sirius XM's side. Free cash flow nearly doubled last year on just a 7% uptick in its top line.
The synergies behind the merger of Sirius and XM have been kicking in over the past three years. The company may have instituted a 12% pricing increase last month, but content and programming costs have actually declined over the past year -- and that's before factoring in the growth in subscribers.
Sirius XM is another five years away from its next costly satellite deployment, so the next few years will be kind as one works through the cash flow and income statements. Slow revenue growth doesn't really matter. As long as revenue -- and ideally subscriber counts -- is pacing in the right direction, earnings, adjusted EBITDA, and free cash flow should take even larger steps.
According to Bazinet's model, Sirius XM's stock can appreciate at a 15% annualized clip between now and 2015 -- a pace that is well off the huge gains that Sirius XM has delivered since bottoming out three years ago, but well above the market's historical return rate -- and still find itself at half of today's free cash flow multiple.
Better than you think
If Sirius XM beats the market over the next four years and is trading at 14 times free cash flow would it still be considered overvalued?
Keep in mind that today's top dog in satellite entertainment -- DIRECTV (NYSE: DTV) -- currently fetches a higher multiple. Unlike DIRECTV, Sirius XM is able to control most of its content and programming costs.
There's also the accounting advantage of Sirius XM's bloody past. The satellite radio giant has $9.8 billion in accumulated deficits since its inception, and most of that -- net operating loss carryforwards of $7.8 billion -- will be used to offset future taxable profits. The attractive model and tax-advantaged future earnings are why some investors believe that Liberty Media (Nasdaq: LMCA) may decide to increase its position from a passive 40% preferred share stake instead of cashing out and laughing all of the way to bank.
Betting on the over
Bazinet is targeting 1.5 million net new subscribers this year for Sirius XM, well ahead of the 1.3 million additions that the company is presently publicly modeling.
I just went over the factors keeping CEO Mel Karmazin at 1.3 million, despite adding 1.4 million and 1.7 million net new accounts in 2010 and 2011, respectively. Between last month's rate hike and soft conversion rate trends, 1.3 million isn't as shabby as it seems.
However, Bazinet still feels that strength in the auto market will result in roughly 800,000 more gross adds than Sirius XM experienced last year. It also only helps that Karmazin has a history of aiming low and revising along the way.
Save for one recession-smacked run in late 2008 in which Karmazin had to dramatically scale back his targets, Sirius XM figures have erred on the side of being conservative. As I pointed out yesterday, a year ago at this time Karmazin was only expecting to close out 2011 with 1.4 million more subs than it started with.
As Sirius XM continues to prove that its scalable model is working -- and its stock price holds above the $2 mark -- expect other analysts to begin inching their price targets higher.
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.
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