Sirius XM Goes 3-for-3
The quarterly report itself wasn't perfect, but the satellite radio giant did effectively hit on all three points that I was hoping would be addressed.
Let's dive in.
1. "Earnings and subscribers should continue to grow."
Sirius XM's $744.4 million in second-quarter revenue fell short of the $752.6 million that analysts were targeting, but earnings of $0.03 a share blew the $0.01 a share Wall Street was projecting out of the water.
Now it's true that the company's bottom-line results are worthy of an asterisk. Nearly half of its $173.3 million profit came from a one-time pop in investment income, largely the result of cash it received in the completion of its acquisition of its Canadian partner. However, it still would have likely beaten the market there without the windfall.
Head up a few line items higher and operating profits rose at an encouraging 38% clip. In other words, operating margins continue to expand. Shrewd cost controls are the key here. Programming and content expenses have fallen by 6% over the past year despite the larger audience base. There is little reason to expect that to change, driving margins even higher in the coming quarters.
Sirius XM bumped its free cash flow and subscriber targets higher. It now sees free cash flow approaching $400 million this year, up from its earlier $350 million guidance. It also now expects to add 1.6 million net subscribers this year, up from its earlier forecast of 1.4 million net additions.
2. "There will be a rate hike next year, and it will move the needle."
Regulators have cleared the way for Sirius XM to begin raising their basic rates, and CEO Mel Karmazin did reiterate that prices will go up early next year.
Sirius XM agreed to wait until 2012 for the hike as part of a recent settlement.
If you're wondering why the stock opened higher despite the anemic 6% top-line spurt in its latest quarter, there's your answer. Rates will inch higher in two quarters, and pairing that up with the upward guidance in subscribers -- and smart overhead management -- will make this a blazingly more attractive company than it is today.
Karmazin believes a mature Sirius XM can generate EBITDA margins of 40%, and he's a little more than halfway there at this point.
The bigger question here is if listeners will play along.
Subscriber acquisition costs per gross addition have fallen from $59 to $54 over the past year. Programming costs are falling. Perhaps more importantly, average revenue per user is also sliding, partly because of the subscriber retention discounts that Sirius XM offers to customers that it believes it will lose without the markdowns. Sirius XM's conversion rate -- the number of subscribers who become self-paying customers after their free trials run out -- has shrunk from 46.7% to 45.2% over the past year.
Is this really the right time to test its pricing elasticity?
It's clear that many -- if not most -- of Sirius XM's subscribers will be willing to pay more, but the first increase in basic rates for Sirius in its operating history should also have an impact on churn.
This will be a defining moment for the platform, just as Netflix is testing the elasticity of its couch potatoes with its move to bump prices higher on its popular dual plans by as much as 60%.
3. "Sirius XM 2.0 is going to roll out on time, and it will be a game changer."
We finally got a lot of details on the next generation of satellite radio receivers, and most of it confirms what Sirius XM itself and unconfirmed reports have been saying all along.
The personalization feature will be important, because even Apple (NAS: AAPL) and Amazon.com (NAS: AMZN) have thrown their weight behind cloud-based music streaming in recent weeks. We're no longer talking about fledgling upstarts in this space.
All in all, the future should be an exciting yet challenging place for Sirius XM. The satrad star expects to close out the year with $750 million in cash, and it's eyeing share repurchases come next year. Don't read too much into that. There are now 6.8 billion fully diluted shares outstanding, and even inexplicably spending all of its money on a buyback at current prices would only take the share count back to the less than 6.5 billion it was sporting three months ago.
The real drivers here will be the margin-widening potential of next year's hike if it sticks and the market-widening upside of Sirius XM 2.0.
Well played, Karmazin.
What did you think about today's quarterly report? Share your thoughts in the comment box below.
At the time this article was published The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Amazon.com, Netflix, and Apple, as well as creating a bull call spread position in Apple and buying puts in 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 is a subscriber to Sirius since 2004. He does not own shares in any of the stocks in this article, except for Netflix. He is also a member of theRule Breakersanalytical team, seeking out the next great growth stock early in its defiance.
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