Invest in Sirius XM Radio
(NASDAQ:SIRI) because of its strength in free cash flow (FCF) growth – was essentially the thesis of Sirius CFO David Frear.
Frear was was one of the many presenters on the first day of the UBS Global Media and Communications Conference held in New York City from Dec 3 to 5. He first introduced his company by pointing out that Sirius has “managed to carve out a pretty good share of the national radio market,” with $3.4 billion in revenue estimated for 2012, which is about 18% of the overall radio market place. $3.4 billion, Frear highlights, is more than the 2012 revenue projections of rivals Clear Channel
(PINK:CCMO) ($3.0 billion) and Pandora
(NYSE:P) ($429 million).
In a complicated and crowed digital music ecosystem, with the likes of iTunes
(NASDAQ:AAPL), Google Play
(NASDAQ:GOOG), Rhapsody and Amazon MP3
(NASDAQ:AMZN), Frear believes that a subscription-based business model is significantly superior to an advertising-based business model because the former provides consistency in terms of long-term performance and predictability in terms of long-term cash flows.
With 23.4 million pay subscribers in the US as of the third quarter this year, Sirius is far ahead of Spotify (4 million), Pandora (1.2 million) and Rhapsody (1 million).
“We not only get more digital music subscribers, but they also pay us a lot more.,” said Frear. “The numbers speak for themselves - Pandora monetizes at $5.84 per active user per year. ClearChannel, the clear leader in the analogue format of AM/FM radio, monetizes at a little than $12.55 per listener, and we do so at $137.69 per subscriber.”
“What is driving our monetization rate? It’s not music listening – we play the least amount music of anybody in the space, but we have the highest monetization rate. It’s important to play music, but you’ve got to do something more. In today’s world, free-to-consumer music listening is almost everywhere. Diversity of content, from music, news, talk to entertainment, is what sets us apart,” explained Frear.
Sirius has also done a good job at retaining its large subscriber base. Its third-quarter monthly churn rate was a lowly 2%, which is better than HBO’s
(NYSE:TWX) and Netflix’s
(NASDAQ:NFLX) 4-5% average and comparable to DirecTV’s
(NASDAQ:DTV) 1.7% and Dish Network’s
“For a long time, we’ve asked people to think about this business as having about a 70% contribution margin. The way we define that is the variable cost - our revenue share paid to auto companies and royalties paid to the music industry, customer service and billing costs, small line items for costs of equipment sold. If you look over the course of the last eight years, that’s been consistently in the 70% range… [which] is a good marker for the company going forward.
One worry that investors have expressed about the Sirius XM is cost of growing its user base. For the third quarter this year, the company reported a 5% increase in subscriber acquisition costs.
However, Frear asserted that Sirius’s subscriber acquisition costs is dominated by subsidies for new car installations. But the new cars sold with Sirius built into their systems six years ago are now entering the used car market, where Sirius can sell its product without having to provide an installation subsidy. There are only marketing costs. “So as you begin to see the installation leveling out, you also see what amounts to a peak in subscriber acquisition costs. Putting a radio in a car is just another consumer electronics (CE) implementation. We all know that CE tends to get more efficient cost-wise per unit over time, and we expect that to happen in our business,” elaborated Frear. “We should be successful in bringing down the cost of installation over the course of the next several years. That provides for opportunities for scaling of margins."
Sirius expects adjusted EBITDA margins to continue to improve from 27% currently to 40% at maturity.
Frear said that Sirius’ borrowing costs have also gone down significantly as the company has delevered significantly in the past few years. A February 2009 15% note, June 2009 11.25% note, and August 2009 9.75% note have all been repaid, leaving a March 2010 8.75% note the one with the highest interest rate yet to be repaid. The Federal Reserve’s low-interest rates policy has also benefited Sirius, added Frear.
Sirius also does not expect to be paying taxes for the next several years because “the upside of having invested $12-13 billion in getting the company launched over the years is that we have over $7 billion now of NOLs [net operating losses] that will shelter us from taxes,” noted Frear.
Finally, the company will also see a big drop in capital spending in the form of satellite spending once Sirius 6, its next and last replacement satellite in the current replacement cycle, goes up in May 2013. The company will then not have to spend on satellites again until late 2016, “giving us more opportunities to build more cash flow.”
Strong subscriber growth, revenue growth, lower interest expense, lower capital expenditure and cash savings from the use of NOLs equates strong growth of FCF, surmised Frear.
For 2012, FCF is expected to increase to $700 million from $416 million in 2011 and $210 million in 2010.
“What will we do with all that money? We could acquire things [though] we haven’t seen anything yet that makes sense for the company to buy,” said Frear. “To the extent that we don’t have anything to buy, then I think the best thing we can do is provide capital back to shareholders; that can be done in form of either dividends or stock buybacks. We’ll certainly be having those discussions with our board and we’ll get back to you soon.”
No positions in stocks mentioned.
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