1.3 Million Reasons to Like Sirius XM

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Sirius XM Radio (NAS: SIRI) initiated its subscriber guidance last week. The satellite radio giant expects to close out 2012 with 1.3 million more subscribers than it has now.

Some investors aren't impressed. Didn't Sirius XM tack on 1.7 million net accounts last year and 1.4 million more subs the year before that? Auto analysts see 2012 as the strongest year for new car sales in years. If new car smell is the lifeblood for satellite radio growth, why is CEO Mel Karmazin being so conservative?

Well, let's go over why closing out this year with 23.2 million subscribers won't be so shabby after all.

There's no such thing as an immaterial price increase
Sirius XM initiated a price increase last month. The company estimates that it will take 18 months for the hike to work its way through its existing members, but new accounts are getting hit with the 12% increase right away.

How can that not influence the conversion decision?

Let's set aside Netflix's (NAS: NFLX) poorly received summertime plan to split its DVD plans from its streaming service. The move -- which essentially boosted prices by as much as 60% -- led to a flood of defections during the third quarter, and DVD plan subscribers continue to move on.

Let's look at the more modest increases at Costco (NAS: COST) and Coinstar's (NAS: CSTR) Redbox.

Warehouse club giant Costco bumped its annual memberships 10% higher in October. Redbox increased the price of its DVD rentals by 20% to $1.20 a night a few weeks later.

Redbox parent Coinstar still pulled through with blowout quarterly results during the holiday quarter. Analysts see modest growth out of Costco when it reports later this month. However, the strong numbers don't mean that the higher prices didn't scare away at least some customers. Price matters. How can it not?

Applause for 1.3 million
There is a finite number of potential Sirius XM subscribers, and it's not simply the number of cars on the road. There is certainly potential for Sirius XM on boats, planes, and even at home, but let's look at the auto market where radio is largely consumed.

Peer-to-peer auto-sharing leader RelayRides claims that the average driver spends an average of just an hour a day on the road. Paying $14.49 a month -- or nearly $16 a month after tacking on the unpopular $1.42 monthly U.S. music royalty fee -- isn't going to be the same value proposition for a driver that's just using the car to shuttle the kids to school or make a short commute to work as it is for trucker or a courier. The higher the price, the smaller the potential market.

Sirius XM made it clear during last week's call. Karmazin claims that churn will increase from 1.9% last year to 2.1% this year based on the increase alone.

Let's work the math here. Churn is essentially the monthly rate of users canceling the service. At 2.1%, we're talking about roughly 460,000 cancellations a month for Sirius and XM services. The difference between 2.1% and 1.9% is close to 44,000 members. This isn't a big number, but over the course of the year we're talking about more than 500,000 subscribers canceling because of the price increase.

If it wasn't for the increase, one can argue that Sirius XM would be targeting 1.8 million net new subscribers this year.

Off the assembly line
More cars do mean more factory-installed receivers. That's great. Unfortunately, conversion rates -- the number of drivers who turn into paying subscribers once their free trial offers end -- have been inching lower over the past year. Just 44% of drivers are sticking with satellite radio, compared to 45% during the fourth quarter of 2010 and 46.4% during the fourth quarter of 2009.

Is it the popularity of free streaming alternatives for smartphone owners? Pandora (NYS: P) struck several new deals last month, bringing its tally to 23 automotive partners for seamless digital listening. Is it the maturing market? It can be rightfully argued that many of today's new cars are simply being bought by owners replacing their existing service.

Regardless of the reason, conversion rates at this year's higher price points are likely to continue to inch lower.

This isn't the end of the world for Sirius XM. This is a scalable model, and we're talking about simple math. Fewer additions paying more is still good business. There's a reason why Sirius XM expects revenue to climb 10% this year, while targeting adjusted EBITDA to rise by nearly 20%.

We also can't forget that Karmazin has been historically conservative in his outlooks. A year ago at this time, Sirius XM was only expecting to add 1.4 million more subscribers to its rolls in 2011. Reality delivered 1.7 million new members.

So cheer up, investors. The subscriber guidance isn't that bad based on the headwinds -- and it's probably too low based on Sirius XM's history of where it sets the bar.

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.

XM Satellite Radio was a Rule Breakers recommendation before the Sirius XM merger. It's now gone from the scorecard, but if you want to discover the newsletter service's next Rule-Breaking multibagger, a free report reveals all.

At the time this article was published The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services have recommended buying shares of Costco Wholesale and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story, except for Netflix. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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