2023-03-11 03:39:17 ET
Summary
- Sirius XM has lost over one-third of its value as guidance reinforces worries of a slowdown in growth.
- The current drop has become overdone and oversold, and now prices in a flat growth rate along with negative equity.
- Debt and interest payments are high with low cash, which poses a risk to this bullish thesis.
- I expect current headwinds to hurt revenues slightly, yet I see this to be a stable business for the long term.
Introduction
The current drop in Sirius XM's (SIRI) share price provides a decent opportunity to buy the company. Sirius XM has had a good track record in maintaining profitability and growing their revenues, and I would expect them to at least stay profitable during these difficult times.
However, there are some significant risks to investing in the company, and so this is a journey for the brave and the believers in the business model.
Company Profile
Sirius XM is a company that provides a variety of audio services , ranging from ad-free satellite radio, podcasts, news and sports through Sirius XM or curated music content both ad-supported and ad-free on Pandora. Their programming can range from premium, in-house content to exclusive content licensed from other businesses or artists. They hold several channels across all three of their primary plans of which their customers can find the music or media they desire to consume.
Their main way of making money is from advertising on Pandora and select non-music channels in Sirius XM and their subscription-based business model.
They deliver their Sirius XM through car dealerships (used and new) and their primary store and have agreements with certain manufacturers to bring their automotive platform called 360L to the infotainment systems that are built into modern cars.
According to their latest 10-K filing , Sirius XM has 34.3 million subscribers and Pandora has about 6.2 million subscribers.
Why I'm Buying
I believe that the recent drop has been overdone and has a very similar steep drop-off seen in the stock price before that usually is followed by a quick rally at some point. The company's fundamentals look about slightly worse, but nothing that shouldn't be too surprising considering inflation, the automobile market and the state of the consumer. However, the company's current investments, which also affect profitability, can also lead the company to become a stronger Sirius XM once out of this incoming recession.
I believe the main issue that might have triggered the massive sell-off is the guidance that might have turned investors' worries of a slowdown in the car market into reality. However, there are more factors contributing to this, which are indeed listed in the earnings call they held about a month ago. A few other examples are the cash flow pressures seen in certain Capital Expenditures (CapEx), such as the launching of their newest satellites and increased royalty expenses due to inflation.
These in combination might as well have been the cause of a massive price recalculation for the stock, since the low growth profile is in danger due to a near-term recession. For context, revenue guidance for 2023 is $9 billion, about flat year-over-year, EBITDA is $2.7 billion, down year-over-year, and free cash flow, of which incorporates their expected increased expenses, will be about $1.05 billion.
However, the company's stock is currently behaving like if Sirius XM is predicting it will fall off a cliff, very similar to what happened to Netflix (NASDAQ: NFLX ) and Meta (NASDAQ: META ) after their respective Q4 2021 results.
Meanwhile, the company has been about as stable as the stock has been. If anything, the company is in a better position now than it has been pre-pandemic and I don't foresee a major shock to their profitability. This is further supported by the company's cost-cutting initiatives announced in early March and their guidance.
With a decent yearly earnings rate and a well-covered dividend, I believe that an excellent buying opportunity lies right now in this company. How long might it last? I honestly don't know. The future is still uncertain and so the fundamentals may either worsen, or the company manages to appreciate enough for that buying opportunity to close. Regardless, I don't hold any regrets holding the stock through the current downturn.
Advantages
I think Sirius XM has a few advantages that make it a good investment that can appreciate over time, which I'll mention beginning with their 360L platform.
The Sirius XM 360L platform is somewhat of an upgrade for Sirius XM, as it incorporates both their satellite and streaming services onto one platform, allowing for a major expansion into new channels that were previously not easily accessible in the car (as you had to use your phone back then to "listen through the car" via methods like Bluetooth)
I think this is one of their biggest competitive advantages as it boosts the experiences and offers a quality-of-life upgrade for consumers and provides all of the content in one space. It is slowly becoming available with brands like Nissan ( NSANY ) and Lamborghini ( VWAGY ) agreeing to start offering 360L for some of their models. Here's the full quote from the earnings call:
Our state-of-the-art 360L platform is quickly becoming the new standard for SiriusXM and is now available in 20 OEM brands with the additions of Jaguar, Land Rover, Lamborghini and Nissan vehicles in 2022.
- Jennifer Witz, CEO of Sirius XM
Next after that, I'm sure some consumers would balk at some of the prices for what would seem to be a glorified radio system, and I wouldn't blame them for that. Their most popular plan costs about $18 per month, which would compete with the likes of Netflix for premium streaming services ($15.5 for standard, $20 for premium). This could be a risk, however, there is one specific consumer that this kind of service would appeal to: Affluent consumers.
While Sirius XM is attempting to appeal to younger consumers as well, a good portion of their consumer base seems to be from the mid-high class and above, which can be an advantage for the company as these customers are less likely to leave because the service is too expensive for their liking. Instead, we head into the next advantage that Sirius XM has, which is their low churn rate. Here's what Jennifer Witz had to comment about it:
I'm also proud to share that we delivered record high ARPU and record low churn in 2022, a reflection of subscribers' high satisfaction with the premium listening experience we continue to evolve and enhance.
I agree here. I believe that while it isn't normal for their churn rate to be this high, I do also believe that in combination with the prior advantage, a low churn would mean a highly sticky, loyal customer. Despite their low penetration compared to other competitors in the entertainment space, they have proven to be effective at satisfying their customers, which can help with Sirius XM becoming more popular through the most powerful marketing mechanism on the planet: word of mouth.
Weaknesses
However, it is important to take a step back, because like I said, Sirius XM isn't for everyone, and their growth is currently limited to the USA as far as I can tell from the filings and earnings call. While they have expanded to Canada, it is clear that they might not have as much confidence in expanding internationally, as they hold a 70% equity interest in the separate entity, with 33% of the voting power. Similarly, Sirius XM Canada has 2.6 million subscribers, which is a lower penetration rate than the USA.
For the time being, I define penetration rate as the percent of the population that currently is subscribed to Sirius XM. This isn't the best measure as it also includes people without financial power (minors, homeless, etc.), but I believe it provides a decent enough insight into how well a company does internationally.
And considering that Sirius XM has a penetration rate of 10.3% in the US against Canada's 6.8%, there certainly seems to be a correlation between separating the company's Canada operations as a protection method to the main company. It could be possible that they work more efficiently as separate entities, so what I say should be taken with a grain of salt and simply make your conclusions based on the data.
However, this also brings us to another facet that puts Sirius XM at a weak spot, especially in these uncertain times where the consumer may get weaker at any moment, which is that they are not an essential company. While the affluent consumer won't mind spending $18 a month even during a recession, it is important to note that doesn't mean that there aren't any middle, mid-low and low class subscribers, which would be happy to use those $13-$22 a month to feed themselves or their families. This could provide a headwind for the next few years depending on the severity of the recession or depression.
This can also limit their growth as there's only so many consumers that they can reach out to, especially if they don't expand to other markets. However, I think it is indeed wise to focus on the tried-and-true for now and improve what I believe to be their employee relations.
Looking at employees' anonymous reviews on Glassdoor , it is clear that there are inconsistencies with Sirius XM's employee experience. Some reviews seem to be blankly fine, while others tend to go more in-depth with some of the problems that Sirius XM is going through, such as a problematic pay gap between hierarchies, lack of upward mobility and shifting quotas for certain sales employees. Looking through several pages offered me a bit of insight as to what working at Sirius XM is like.
The 3.8-star rating is not bad - it is better than most - however recent reviews are highlighting a few problems. Some of them are already known to be common for the audio industry as a whole in this digital age, while some seem to be inconsistencies within segments of the company.
Before moving on, I'd like to finish talking about employee reviews with a clear example shown by an employee of one of the issues for the audio industries.
Like many entertainment employers, SiriusXM exploits hungry music and tv lovers, willing to do more for less, because if they don't there's someone next in line who will.
- Anonymous Former Employee
Finally, while these reviews are anonymous, tend to have biases based on their personal experiences and may not be reflective of the company, I do take it into account as employees tend to be more productive when they are happy. This can result in improved margins as the company gets better bang for their 5-6 figure salaries.
Another weakness that was certainly mentioned in the company's call is the slowdown in the advertising market. Here's the statistic mentioned in the company call:
Q4 and full year total advertising revenue were essentially flat year-over-year, with Q4 down 3% and full year up 2%, respectively.
It is nothing new to people that nearly every advertising business has been suffering one way or another, with companies like Snap (NYSE: SNAP ), Google (NASDAQ: GOOGL ), Unity (NYSE: U ) and Meta feeling the brunt of an advertising slowdown. Businesses are simply focusing on cash preservation, so they have to cut their advertising budgets . This could pressure Sirius XM's overall revenues and earnings for as long as the advertising market slowdown lasts.
All of these mentioned above are only some of the risks implied with investing in Sirius XM, as well as the company's stock cratering and not coming back to prior levels for a while. I suggest doing your own research and evaluate whether the company is a good investment for you; however, I remain bullish on this company for the long term.
Recent Earnings
Earnings have had their reason to be rather mixed. While the company continued showing that much beloved stability, there are cracks to be seen, which can pose a risk to this bullish thesis.
2022 | 2021 | |
Revenues | $9B | $8.7B |
Operating Costs | $7B | $6.7B |
Operating Income | $2B | $2B |
Net Income | $1.2B | $1.3B |
For one, their margins are shrinking as their overall costs rose as much as their revenues, which can pose as a threat. However, let's try to investigate those costs more in-depth:
Total operating costs (Sirius XM)
I love it when a company provides so much detail into their consolidated statements. While I wouldn't expect much of a change in their overall cost of services, I do say that there's plenty of room for the company to cut on their overall sales and marketing department, as it consists about $1 billion of their total costs.
However, outside of that big metric, the company can only optimize spending marginally in other metrics. Yet, those are at least under control. As would be expected, the cost of revenue sharing and royalties as well as the costs of programming and content are the biggest drivers of the overall increase in expenses.
Speculating, I believe the only possible way to reduce those costs is by cancelling and shutting down certain programs that have low viewership. However, that can hurt customer loyalty as most people would feel betrayed after seeing their favorite show or channel, even if it's one few people listen to, cancelled to save costs.
Then I head onto to their balance sheet and off the bat, I see Sirius XM playing a risky game with their cash balance.
If you look into their interest expenses, they're relatively high. After a massive special dividend given to shareholders last year, it is in our best interest that the company saves up as much cash as possible to brace for worsening conditions. This is especially necessary to at least have a cushion to pay their debtors, who have given Sirius XM quite a lot of money.
The good news is that they have been paying off their overall debt, which can explain why cash decreased as of late. However, they're going to need to do more, especially as they currently bear negative equity.
Sirius XM
So, hopefully Sirius XM can realize some of their planned cost savings and use that money to pay down debt and shore up some cash for their economic outlook. Just because their business is resilient now doesn't mean that the business will withstand anything that occurs in the economy. Tragedies do happen more often than miracles.
Valuation
As for valuation, what can we do about it? I won't sugar-coat it, Sirius XM might as well earned their current valuation. However, I don't believe that a crash this severe would be justified if it were for the guidance alone, especially when investors were fine paying $6 per share for a company with relatively similar fundamentals to the current Sirius XM.
However, the growth profile will be halted, and I do want to cushion for any potential declines in revenues. As such, their valuation metrics will be cut slightly for this.
Revenues won't be utilized while we can use their significant EPS, while their negative equity will help subtract some of the valuation that may result from the 15x EPS ratio. I will also use a 15x free cash flow ratio for their cash flow valuation. Here are the metrics:
Metric | Value | Ratio |
EPS GAAP | $0.31 | 15x |
Equity | ($3.35B) | 1x |
Free Cash Flow | $1096M | 15x |
Taking these valuations in mind, their EPS GAAP valuation would result in a price target of $4.65, or a market cap of $18.09 billion. Meanwhile, a 15x free cash flow valuation would place the company at a market cap of $16.44 billion, or a price target of $4.23.
Then, if we take into mind the negative equity reduction in valuation, this will punish the company's valuation by about $0.86 per share, leading to respective valuations of $3.79 per share and $3.37 per share.
Now, this is a surprise for me, considering I wasn't expecting any negative equity and I was alright valuing this at 20x. But I need to be honest with myself and my readers, I can't use my standard if growth will stagnate. However, do keep in mind that if revenue growth was at least 5%, the standard would be used again.
For context, this is what a 20x valuation would look like for each metric:
Before Equity | After Equity | |
EPS GAAP | $6.20 | $5.34 |
Free Cash Flow | $5.63 | $4.77 |
So, I do believe it is still important to mind that potential upside should investor worries prove to be overblown.
However, for the time being, I won't justify a high price target until there's more clarity. This is an opportunity to buy for those who believe in the business model and the business itself. Otherwise, there's likely better companies that aren't living on the edge like Sirius XM is doing.
Conclusion
In the end, Sirius XM is a pretty good company with a solid business model. It has proven to be resistant to the headwinds presented by 2022 and it has the opportunity to grow in the future. However, I do believe that current headwinds may pose a risk to this bullish thesis, and so I wouldn't want to pile in the company either.
My rating will of course seem contradictory to how the facts look, and this is where my thesis will be at great risk. However, I am one of those believers and will stick with this company until something significant happens that forces me to reconsider my position, such as losing profitability.
I rate Sirius XM a Buy with a price target of $4 for the time being.
For further details see:
Sirius XM's Drop Opens A Buying Opportunity For Investors