It's a Bad Time to Be Bearish on Sirius XM

The way some analysts take chances you'd think that Johnny Knoxville was egging them on from the other side of the camera.

Barclays Capital analyst James Ratcliffe is the latest Wall Street daredevil.

Ratcliffe initiated coverage of Sirius XM Radio (NAS: SIRI) yesterday with an underweight rating. His near-term price target of $2 -- at a time when other analysts are perched as high as $3 -- is bold. The stock closed yesterday at $2.12.

It's an interesting time to begin covering a company and pointing down. Sirius XM reports its fourth-quarter results tomorrow. Ratcliffe is either going to be crowned a genius or laughed off as a buffoon. There's no in between here.

Cracking open Pandora's box
Ratcliffe is smart enough not to pin his bearish thesis on the runaway success of Pandora (NYS: P) and the crowding automobile dashboard.

Sirius XM has proven that there is plenty of growth for several companies to share.

The satellite radio giant shed 231,098 net subscribers in 2009, only to add 1.4 million accounts in 2010 and another 1.7 million in 2011. Every single year finds more people owning smartphones and buying cars through which they can stream smartphone apps. Pandora's growth in that time has been downright explosive.

Well, if all of this is true, then why is Sirius XM not only growing, but actually accelerating its subscriber rate?

Thankfully Ratcliffe isn't going there, rightfully pointing out that the fast-growing music-discovery service is a "real, but manageable" threat. If anything, Ratcliffe argues -- as many bulls have in the past -- wireless carriers moving to tiered pricing will make Pandora and other "free" streaming content more expensive than consumers think.

Playing the valuation card
Ratcliffe is more logical than passionate about his gutsy coverage initiation. He simply feels that Sirius XM is overvalued. The stock's already trading at 14 times his estimated EBITDA target for 2013 and 19 times next year's free cash flow if it was fully taxed.

Instead of Sirius XM, he suggests Liberty Media (NAS: LMCA) , which owns a 40% preferred share stake in Sirius XM but is trading at a discount.

I don't have any beef with that final point. I bought into Liberty Media last year for exactly that reason.

Ratcliffe's bearish case is solid, but the problem is that it lacks imagination.

After all, Ratcliffe assumes the revenue growth rate from 2011 through 2018 will run at an annualized rate of a mere 8.6%. He does see EBITDA and free cash flow moving substantially higher -- and rightfully so given the scalable nature of the business -- but does he really think the combination of subscriber growth and increases in average revenue per subscriber will only appreciate at a pace in the single digits?

That's a bold assumption, and one that may get crushed tomorrow.

Guidance light
It's been five months since Sirius XM initiated its outlook for 2012, and it would be a shock if CEO Mel Karmazin sticks to his target of 10% revenue growth for the year ahead. Sirius XM wound up tacking on far more new subscribers during the fourth quarter -- roughly 540,000 to get to 21.9 million subscribers -- to keep aiming that low. There was a 12% rate hike introduced last month. Auto sales have been strong.

Save for a brief lapse in late 2008, Sirius XM has erred on the side of providing conservative guidance that it can bump up later.

If Karmazin doesn't boost his guidance for 2012, the market won't be happy -- and Ratcliffe will be rewarded for his brazen call practically on the eve before Sirius XM's conference call. If the outlook is raised and the stock rallies, he'll look like a chump for the timing of his call.

Through his goggles I can see where Sirius XM and its roughly 6.5 billion fully diluted shares may seem overvalued. Pit Sirius XM against the two largest satellite-based entertainment companies -- DIRECTV (NAS: DTV) and DISH Network (NAS: DISH) -- and Sirius XM trades at insane relative multiples of revenue and forward earnings.

However, DIRECTV and DISH aren't in the same position as Sirius XM. Sure, folks will always pay more for TV than radio. However, DIRECTV and DISH are at the mercy of their content providers. Sirius XM, for the most part, is its own content provider. Its programming and content costs have actually gone down over the past year, and that's something you will never see happen at DIRECTV or DISH unless they're shedding subscribers.

Sirius XM doesn't have insane pricing elasticity given the limited market of people who spend enough time in their cars to make the service worthwhile, but this is still a monopoly on premium radio in an era where terrestrial radio isn't getting any better and tiered pricing along with throttling will eat into fans of smartphone streaming.

We'll see if Ratcliffe is right tomorrow, but it certainly seems as if he picked the wrong week to come out as a Sirius XM bear.

Still a bull
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 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 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 Liberty Media. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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