For Sirius XM, Satellite Radio Makes a Louder Ka-ching!

hands on wheel and city nightlife

There is a growing number of ways to entertain your ears on the open road, but satellite radio continues to be an increasingly popular choice. Sirius XM Holdings (SIRI) closed out the second quarter with a record 26.3 million subscribers.

The lone provider of satellite radio in America wrapped up the three months ending in June with 475,472 more subscribers than it had when the period began. Sirius XM has tacked on more than 1.2 million net additions over the past year.

The healthy subscriber growth combined with the average account paying slightly more for the premium audio service and strong gains in ad revenue to deliver better than expected top-line growth. Sirius XM's revenue rose 10 percent to $1.035 billion, making this the first quarter in its history with revenue topping $1 billion. Analysts were only holding out for 8 percent growth.

Free cash flow and adjusted earnings grew at an even headier pace. The gains came despite marketing, customer service, and royalty payments all growing faster than Sirius XM's subscriber growth.

The model works. This is a very scalable business with high fixed costs and low variable expenses. As long as Sirius XM keeps growing its user base, it won't be a surprise to see the company's bottom line growing even faster. The challenge is its ability to keep listeners coming.

Turning the Dial

Sirius XM has defied the naysayers. It's been consistently profitable for three years, and that's a big deal since it was on the brink of bankruptcy just five years ago. The 2008 merger between Sirius and XM worked. The cost savings and inertia of the medium have propelled Sirius XM into a media giant that will generate $1.1 billion in free cash flow this year. That's not too shabby for a company that was so hard up for cash in 2009 that it gave up 40 percent of the company to Liberty Media (LMCA) just for the right to lend it some money.

%VIRTUAL-WSSCourseInline-799%Still a challenge is wider smartphone adoption. And new cars are rolling out with advanced features that allow drivers to stream music apps through their dashboards and vehicle speakers. However, many folks trading in old cars for newer models are buying into vehicles with factory-installed satellite radio receivers for the first time. This is why we're seeing subscriber growth at Sirius XM even though it has instituted two price hikes over the past three years.

Buyers of new cars with Sirius XM receivers convert into paying customers 42 percent of the time. That figure has been drifting lower over the years, but Sirius XM is making it up in volume.

Leveling the Paying Field

The threat of streaming challengers is real. Tech giants are snapping up digital music platforms, realizing that the connected car is the next battleground. However, Sirius XM could be helped out by the greediness of wireless carriers.

The two largest mobile service providers -- AT&T (T) and Verizon (VZ) -- have been weaning longtime customers off unlimited data plans. This means that the free ad-supported music apps aren't free in terms of data usage. The convenience and pricing predictability of satellite radio may not seem like such a bad deal as AT&T and Verizon get hungrier.

Sirius XM is making the most of its recent good fortune to be nearly halfway through its $6 billion in repurchase authorizations. It may want to set some of that money aside in case it needs to follow the tech giants into buying streaming music providers so it doesn't have all of its eggs in one basket, but for now it's a pretty sturdy basket.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of Liberty Media and Sirius XM Radio. Try any Motley Fool newsletter service free for 30 days.

Originally published