Sirius XM: Headwinds Now Reflected In Valuation (Rating Upgrade)

seekingalpha11-22 19:43

Sirius XM shares have significantly underperformed, losing 50% of their value in the past year despite simplifying their corporate structure.The merger with Liberty Media resulted in a 12% decrease in...

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This comes even as it has simplified its corporate structure, which still has not been enough to offset concerns about the underlying business. I have been consistently bearish on shares, reiterating them as a \"sell\" in August. Since then, the stock has lost a further 17% while the market has added 13%. Given the magnitude of its underperformance and with updated financials, now is a good time to revisit SIRI, especially as shares now sit at my $25 price target (adjusting for its reverse stock split). Seeking Alpha On September 10th, Sirius announced it closed its merger with Liberty Media, simplifying its structure. As I wrote in my past articles, while this simplified its investor base and could one day pave inclusion into the S&P 500, the terms were not particularly compelling for existing SIRI shareholders, in my view. Former Liberty shareholders own 81% of the new SIRI with existing SIRI holders owning 19%. There are 339 million shares outstanding as a result of the transaction, a 12% decrease. Alongside this announcement, the company has announced a $1.166 billion share repurchase authorization. This is really an extension of its prior program but needed to be re-authorized given this is a \"new\" Sirius. The company continues to target mid-to-low 3x debt/EBITDA leverage. It will take some time to achieve this goal. After the deal closed, it now carries $127 million of cash and $10.7 billion of debt. As a result, it has 3.8x debt to EBITDA. At its current EBITDA run-rate, it will need to reduce debt by about $1 billion to hit its target. Until we see it get closer to this threshold, I do not expect material buybacks. The company does continue to pay a $0.266 quarterly dividend, which provides shares with a 4.3% yield. Given its quarter-end share count, it has a go-forward $375 million annual dividend cost. With its underlying free cash flow, I view its dividend as very secure, though it will lengthen the time it takes SIRI to achieve its leverage target. Turning to its actual results, in the company's third quarter reported on October 31st, Sirius lost $2.96 billion, due to a non-cash impairment of goodwill ahead of its deal with Liberty. The charge was $3.36 billion and reflects the consistently low share price, which forced a goodwill test. SIRI generated $2.17 billion of revenue, down 4% from last year, given pressures on subscriber revenue and advertising. With lower revenue, EBITDA fell by 7% to $693 million as margins contracted to 32%. Sirius XM is its key segment, of course, and revenue fell by 5% to $1.64 billion, due to an $87 million decline in subscriber revenue. Advertising was essentially flat at $41 million. As you can see, this business is really powered by subscribers, as most of its content is ad-free. It generated $969 million of gross profit for a 60% margin, down from 61% last year, due to lost operating leverage. Sirius did add 14k self-pay subscribers, Meanwhile, it lost 114k promotional subscribers as negotiations with carmakers meant that new car trials converted to free. It now has 33.2 million total subscribers, down 800k from last year. As you can see, its subscriber performance was better than last year by 110k, but it still is fairly subdued. SIRI also is increasingly reliant on promotions to attract subscribers. As a result, average revenue per user (ARPU) was $15.16, down $0.53 or about 3.3%. Sirius XM One headwind for future growth is that Sirius now has 7.3 million free subscribers from 7.5 million last year. The smaller funnel of free subscribers creates less of an opportunity to convert users to paid subscriptions, which is one reason I am cautious about subscriber growth next year and continue to see Sirius as a slowly melting ice cube. While it is struggling to add subscribers, its existing base does love the product. This has resulted in a self-pay Sirius churn of 1.6%, stable with recent trends. Additionally, a key moment for Sirius to win a customer is when someone buys a car, as it often comes with a temporary subscription. New car sales continue to run below pre-COVID norms, and a slower pace of car sales naturally reduces the pool of potential subscribers. This is a problem largely out of Sirius's control. With sales running below pre-COVID levels, I do not expect a further deceleration, barring a recession. That said, given the elevated rate environment, I do not see a clear catalyst for car sales to rise next year, which will constrain subscribers. St. Louis Federal Reserve Beyond Sirius XM, the company also owns Pandora. Here, revenue fell by 1% to $544 million as advertising revenue fell by 2% to $409 million while subscriber revenue rose by 2%. While Sirius gets about 90% of revenue from subscribers, Pandora gets about 75% of revenue from advertising. The national advertising market has been constrained as businesses become more cost conscious. Encouragingly, gross profit rose by 4% to $187 million as margins were 34%. It raised prices on Pandora premium subscriptions. Pandora lost 76k paid subscribers to 5.9 million, a modest decline given the price increase. During the quarter, it generated just $94 million of free cash flow. There were $72 million of transaction related expenses, which should not recur. So far this year, Sirius has generated $499 million from $780 million last year. There have been $412 million of working capital outflows from $106 million last year, which explains most of this decline. In Q4, we should see working capital recover and boost free cash flow. Due to weaker advertising, it cut revenue guidance by $75 million to about $8.68 billion, which should still result in $2.7 billion of EBITDA and $1 billion of free cash flow. I continue to expect about $1 billion of free cash flow given at least $300 million of working capital swings in Q4 alongside run-rate free cash flow in the business. Looking forward, SIRI continues to target 25% subscriber growth and 50% free cash flow growth. Satellite cap-ex should fall by 40% next year to $180 million and continue to decline, which is one reason why free cash flow should rise more than subscribers. More fundamentally, I struggle to see the path to subscriber growth. The company had over 40 million subscribers at the end of 2019. Essentially, it has not grown at all, even as it has invested in content. Sirius XM As such, I remain very skeptical of its ability to substantially grow subscribers, particularly given how much competition there is for consumers' time, between podcasting platforms and more streaming offerings. Ad-supported platforms could potentially grow their base, but that may cannibalize existing subscribers, and ad revenue is likely to be more volatile than recurring subscription fees. As such, I continue to view the base case as flat to modestly declining subscribers. Now while I have been bearish, I try to take note of those with differing opinions, especially when they are Warren Buffett's Berkshire Hathaway (BRK.B). Berkshire has recently added another $60 million of stock, and it owns about one-third of the company. While this is a very large position in the company, I would note this investment is fairly small in the scale of Berkshire at about $3 billion. Given its size, recent purchases may have been made by a deputy rather than Buffett. Berkshire does have a history of investing in John Malone's businesses, including Charter (CHTR) and various Liberty entities. Frankly, I think Berkshire was early in owning such a large stake, given the shares' performance. At higher prices, SIRI was discounting potential growth, but at $25 that is not really the case anymore. I assume subscribers will be flat to down 2% next year. This should provide $1-$1.05 billion in free cash flow given lower cap-ex. With ~$600-$700 million in free cash flow after its dividend, SIRI should be at its leverage target by mid-2026 and could then consider buybacks. Shares now have a 12% free cash flow yield. I view this as appropriate given ~2 years before buybacks and the risk of ongoing terminal declines in subscribers. Essentially, SIRI can shrink 2% per year and still return 10% to investors.  As such, I am now upgrading shares to a \"hold\" as they sit at fair value. If we saw shares move to $23, I would be an outright buyer, but for now, given the declines in the business and recently cut revenue guidance, I remain a hold. SIRI's long period of underperformance is likely over in my view, but at $25, I see it as a market performer vs an outperformer.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2485325252"}