Glenn Rogers writes:
I was thinking of a good way to play the continuing strength in new car sales. The recent reports from the major auto manufacturers were very strong and of course there is nothing wrong with simply making an investment in Ford, GM, or Volkswagen - my three favorites at the moment.
Also, a number of the auto-parts manufacturers like Johnson Controls (JCI) and Borg Warner (BWA) are interesting opportunities.
But the derivative play I particularly like right now is Sirius XM Holdings (SIRI). I was speaking to Gordon about this idea and he reported that he recently bought a new Lexus, which came with Sirius XM satellite radio installed on a three-month trial basis, and that he was really enjoying the service. One of the advantages he noted was that it's possible to listen to CBC while travelling in the U.S.
He is not alone in his reaction. Many of the new subscribers to Sirius XM are acquired in this way. Typically the conversion rate runs between 44% and 46% of new car buyers.
Currently, 70% of the new cars produced come with Sirius XM receivers installed, which is why new car sales are so helpful to the company. This is not to say that the used car market is not important. There are already 57 million cars in the U.S. that have satellite receivers installed but more than 30 million are not active. So converting the new car trials and activating existing radios offers a compelling opportunity for the company. By 2017 the installed base should hit 100 million.
The company has had a long and interesting history beginning with the XM radio debut in 2001. Sirius, which was a competing service at the time, followed a year later. The companies battled each other for six years, which pushed up program costs. The intense competition almost resulted in both companies going under but fortunately cooler heads prevailed and the companies finally merged in 2008.
Since then the company has begun getting its programming costs under control, reducing them from more than $450 million to $300 million this year (figures in U.S. currency). Much of this content is pure music but the company also offers a wide range of news channels, comedy channels, and major league sports, recently adding an exclusive NBA channel which started Dec. 9. Currently the company pays a royalty of 5% to cover the music costs; that will rise to 11% in 2017.
The Sirius XM subscriber base has steadily increased over the years, growing over 35% between 2009 and 2013 for a compound annual growth rate of 7.8%. Last quarter the company added over 500,000 customers which was more growth than any of the satellite/cable television companies such as Comcast or DirecTV. Because of that strong subscriber growth, revenues increased from $2.5 billion in 2009 to an estimated $3.7 billion in 2013, a jump of 48%.
The company is profitable. Back in 2009, Sirius XM earned $463 million and the company will make over $1 billion in 2013. This indicates a growth of 146% since 2009. Profit margins exceeded 30% for the first time in the second quarter and the company is driving towards 40% profit margins. The share price has also increased dramatically since its low of $0.15 December 2008 to the Thursday close of $3.47, which would indicate a stunning increase of over 2400%.
The company should generate nearly $1 billion of free cash flow this year and that is projected to grow to nearly $2 billion by 2016. The company plans to retire about 40% of its equity over the next five years.
Readers will also be familiar with other popular music services like Pandora and Spotify but there are important differences between those and Sirius XM. First, Sirius XM has about 25.1 million subscribers versus 6 million for Spotify and 2.5 million for Pandora. This makes Sirius XM four times bigger than the second-largest competitor. Additionally, both Spotify and Pandora are largely free for users or are advertising supported although both services are trying to drive to a paid subscription model.
There are people who do listen to both services by streaming via their smart phones through Bluetooth or direct connection to their car stereo but this requires unlimited data plans otherwise you risk running up a large cell bill.
Doubtless cars will be getting smarter and before long wireless modems will be built in to the car dashboards allowing for more streaming from other services. But much of this traffic may also be handled through Sirius XM satellites so they may benefit as the technology improves. The company just placed a new satellite in orbit that will allow it to provide more services to a larger percentage of the population.
Liberty Media (LMCA) holds a majority stake in Sirius XM with a 53% position but they have recently announced that they will sell back $500 million worth of shares in the company. They got the majority of that stake because they provided a $400 million loan to the company when was on the verge of bankruptcy, which turned out to be a great deal for Liberty. Prior to the announcement that they were going to sell back some shares, Liberty had spent $1.7 billion increasing its stake to the 53% mentioned above.
I think the stock can continue to appreciate and is not unfairly priced compared to other similar media companies.
Action now: Buy with a target of $5. The shares closed Thursday at $3.47.