There's been no shortage of activity, or intrigue, for Sirius XM (SIRI +0.00%) investors since I first bought shares of the satellite radio provider in December. In an apparent attempt to support Charter Cable's bid for Time Warner Cable, media magnate John Malone's Liberty Media (LMCA +0.00%) threw out a lowball offer to acquire the 48% of Sirius it didn't already own. Shareholders, from all indications, weren't impressed. Unable to advance his cause, Liberty abandoned its Sirius bid in favor of tracking stocks and a rights offering.
A few months passed, and that leaves us just about where we started. I bought Sirius on a simple premise: That it was a cash-generating machine that, under Malone's guidance, would aggressively employ leveraged share repurchases -- compounding value to shareholders at an astronomic rate. That's still going to happen. The market, meanwhile, has cogitated over competing offerings from Apple (AAPL 0.01%), Pandora (P +0.00%), and Spotify, and guidance for slowing rates of subscriber growth in 2014 -- and shares have gotten cheaper.
That mind-set fundamentally misunderstands the strength of Sirius' competitive advantages, platforms, and its ability to turn competition into revenue via its recent Agero acquisition. That's why I'm using the opportunity to buy shares of Sirius XM for my Real Money Portfolio again, in a position equal to 2% of my portfolio's capital.
Turning cash into cash
At the core of my Sirius thesis was a simple, but powerful, premise. Majority-owned by John Malone's Liberty Media, it would employ a classic piece of the Malone playbook -- what wonkish types call a leveraged recap. The mechanics work like this: Sirius, which produces a recurring, high-margin stream of cash flow, can assume a lot of debt, and more than adequately service it. It would use its cash flow and debt to repurchase undervalued shares, supercharging value accretion to shareholders. In a low-rate environment, like today's, that can be particularly powerful.
With the Liberty offer no longer on the table, Sirius is free to resume share repurchases. And if the company takes debt to its target leverage ratio, four times debt to EBITDA, and simultaneously uses free cash flow, I estimate it repurchase up to 15% of its shares outstanding. If Sirius generates $0.18 of free cash flow, a number I think is quite attainable, before share repurchases, and buys 15% of its shares, the number jumps to $0.21. Suddenly, Sirius shares are trading hands for a very reasonable 15 times earnings. For a company that could post double-digit earnings growth for the foreseeable future, that's wicked cheap.
There's good reason to believe repurchases will continue, and at a furious rate: I don't think Malone's done with his Sirius forays. Share repurchases increase his effective ownership of the Sirius enterprise, which could make it easier to effectuate a deal at some later point.
A fading signal?
Much attention has focused around two factors, which have afforded prospective buyers a nice discount: Slowing sub growth, and the possibly damaging effects of competing streaming offerings. On the matter of sub growth, which calls for 1.25 million additions on management's 2014 guidance, I don't think there's cause for worry. For one, the laws of gravity dictate that, at some point, this number slows. Sirius has added more than 1.5 million net subs for each of the past three years, and total subs currently sit at 25 million. A little lumpiness is to be expected. More importantly, even if growth slows to 1.25 million subs, Sirius shares are cheap.
That's, in part, because of a second factor: A promotional agreement with a "large OEM," widely believed to be GM (GM 0.40%), expired at the end of last year. Under the previous arrangement, GM paid Sirius a sum for promotional subs in every GM-equipped car, and kept a share of Sirius' cash flow if and when promotional subs upgraded. Under the new agreement, GM doesn't pay Sirius for trial subs and, in turn, Sirius keeps more money on the back end. The likely implication is accelerating free cash flow growth, even if subscriber growth slows.
Market soothsayers continue to worry about competing offerings from the likes of Apple, Pandora, and Spotify. Foremost, they fail to understand three critical factors: 1) these services carry a whopper of a hidden cost -- data fees; 2) they can be complementary; and 3) they don't offer the depth and breadth of content on tap at Sirius. But even where these arguments fall flat, there's a more subtle point: Sirius can actually use competition to its advantage.
Sirius's Agero platform, what wonkish types call telematics, can make competition its friend. Effectively speaking, Agero amounts to placing a smartphone and operating system in your car's dashboard. Looking forward, Sirius expects to charge for inclusion of its platform (which already has strong relationships with OEMs), and various subscription services offered within it. Placing Pandora, Apple, or Spotify apps into a vehicle dash strengthens Agero's offering, allows it to charge automakers more, and possibly opens a licensing revenue stream for Agero.
Also remember that, while not bite-sized, Pandora and Spotify aren't too big for Sirius or Liberty to acquire. The benefits could be mutual, and huge: Sirius could use its clout with content providers to negotiate lower costs, which could dramatically improve the lot's flagging profitability. Likewise, integrating the Sirius and Spotify/Pandora offerings, and intellectual property, could make for a powerful consumer offering.
The bottom line
In short, the core elements of my Sirius investment remain intact. The signal's strong, and the price is better. That's why I'm back for more.
