• The Liberty SiriusXM Group and Sirius XM finally announced a transaction to merge Liberty SiriusXM and Sirius XM.
• Although there are no real surprises in the deal, the stocks involved don’t really get moving in either direction, which simply can’t be right.
• As a result, there is an opportunity for a 50%+ return within 6-9 months.

Liberty SiriusXM and SiriusXM agree to merge

As widely expected (and for far too long), The Liberty SiriusXM Group (NASDAQ:LSXMA) (NASDAQ:LSXMK) (NASDAQ:LSXMB) and Sirius XM Holdings Inc. (NASDAQ:SIRI) have finally agreed to merge. This means about nine months from now Liberty SiriusXM shareholders will receive approximately 8.4 shares of the new SiriusXM, thus owning a total of about 81% of the new company, while the current minority shareholders of Sirius XM Holdings will own the remaining 19%.

The transaction is expected to be tax-free, and there are no potential obstacles to its approval, given that Liberty already owns 84% of SiriusXM and effectively controls the company. Minority shareholders of SiriusXM won’t vote on the deal, while Liberty Media’s shareholders will – but there can’t be any doubt how John Malone with his super-voting B-shares, alongside large owners like Berkshire Hathaway (BRK.B) (BRK.A) and Seth Klarman, will decide: Liberty SiriusXM trades for less than 70% of its underlying value, which means that collapsing the discount is the most accretive thing to do.

The 81/19 ownership split is the result of a months-long bargaining progress, at the beginning of which stood Liberty’s proposal to compensate SiriusXM minorities for the additional debt assumed in a merger via a cash dividend. This solution was not adopted, as it would have burdened SiriusXM with even more debt. Instead, Liberty will give up about 3% of its ownership interest in exchange for minorities assuming more debt.

You can review all the details in today’s slide set.

But the NAV discount doesn’t close

What is most interesting about this deal is that, as I write, there remains a huge discrepancy between the intrinsic value of the Liberty SiriusXM tracking stocks and their trading price. As of now, the trackers trade for about $27, while 8.4x Sirius XM’s price of $4.8 would result in a value of more than $40.

So what is wrong here? Is the market just nuts?

For a long time, there has been that idea out there about SIRI being the overvalued stock of the pair, given its massive share repurchases and low liquidity. Instead, the LSXM trackers would have been the fairly and efficiently valued stocks. I personally doubt that theory, but this is what some investors were saying. Today, it certainly looks like nobody wants to bid up the tracking stocks, while SIRI even traded lower after the announcement (after being up 10% yesterday).

It might rally a few minutes from now – who knows? At least this is what SIRI has represented over the past few months: a textbook example of stomach-turning volatility.

Why the NAV discount remain elevated

My personal explanation for the phenomenon is rather short-termism: Given the small trading float of SiriusXM stock, coupled with an outsized short interest (which is probably not mainly due to an assumed overvaluation, but simply to the many arbitrageurs out there that wanted to bet on the closing of Liberty’s trading discount by going long LSXM and shorting SIRI), the stock market has been extremely inefficient for SIRI shareholders for a long time. Frequent brutal selloffs have been followed by massive short squeezes.

Hence, until LSXM shareholders finally get their hands on their SIRI stock and the float increases, there will be a lot of volatility. Technical issues and supply/demand imbalances will have huge impacts, a few of which have been examined in my recent article on the situation.

The stock market will start to price in the exchange ratio of 8.4x between the two classes of stock of the same company over the next few months, and when SIRI suffers from one of its low-float selloffs, LSXM trackers will probably suffer as well. Or not, who knows?

In a nutshell: For anybody looking for short-term results, this is no attractive situation, unless we are talking about ultra-short-term, super-speculative trading. If you own stocks only for minutes, fast movers are great.

Bargain alert for value investors

Long-term oriented folks will need to fasten their seat belts. In the meantime, it should help to have a clear view of what they effectively own: a piece of SiriusXM.

Each share of the Liberty trackers (the K, A and B shares from today will yield exactly the same result, as they will treated as a single class of shares) gives its shareholder a claim on the profits belonging to 8.4 shares of the new SiriusXM, which will likely earn $1.5B of free cash flow, or FCF, within a few years (once the current massive investment phase in new satellites will be done) and have 3.4B shares outstanding, so the FCF belonging to each share of the LSXM trackers will be $3.70 in 2025 or 2026.

Even if FCF stagnated at the current level (unlikely, since it is heavily depressed by this year’s additional investments to the tune of ~$300m), FCF per current LSXM tracker would still be around $3. This means the trackers have a current 11% look-through FCF yield, which is likely to increase over the next few years.

From a purely fundamental point of view, this looks pretty attractive to me, and I certainly won’t sell a single share at these levels and won’t offload my SIRI stock once received as long as it continues to carry an 11% FCF yield.

However, not many fund managers can own such volatile stocks, where basically anything can happen every day. So, the current discount seems a “volatility discount” to me, unrelated to business fundamentals.

The theory that a stock like SIRI with its tiny trading float can still be overvalued while having much of its float sold short sounds implausible to me. Why would SIRI stay stubbornly overvalued while everybody knows that it should fall some 20-30% within a few months and while it is attracting short sellers due to the LSXM/SIRI arbitrage trade?

And even if there was some pressure on the stock close to its merger or right afterward (LSXM shareholders might sell their new SIRI stock right away), the very likely index inclusion of this $19B company with the resulting buying spree by index funds should compensate for that.

If you can stomach the volatility, you will probably be richly compensated. I believe the new SIRI shares will settle around a more common FCF of yield of about 7%, i.e., they should trade for about $43 – and grow from there, as lower capex levels kick in and FCF grows over the subsequent years.

This means current LSXM holders can expect a return of about 50-60% within one year.

Risks are almost negligible

The downside is pretty negligible, in my view. Even at SIRI’s recent multi-year lows of about $3.50, the underlying value of the LSXM trackers would still be $29.40, i.e., about 9% higher than today’s trading price. At that point, the stock would trade for a look-through FCF yield north of 10%.

That said, some readers will question my FCF estimates: Why should FCF grow? After all, SiriusXM enjoyed an extremely low tax rate until recently but has now become a full taxpayer. However, the company is looking to lower its tax rate and will soon come up with some tax optimization, as it stated at a recent conference:

And as we look ahead, we certainly hope that there’ll be some opportunities to reduce taxes and we have some thoughts on that, that we’re not ready to share yet, but I do think there’ll be some improvements in our tax profile going forward as well.

Moreover, despite giving usually rather conservative guidance, the company sounded very confident in being able to grow FCF going forward:

I think as we look beyond next year, because we still have sort of satellite CapEx at a high level, and non-satellite maintenance levels for the new platform at a pretty high level. As you look beyond to ’25 and forward, we would expect free cash flow to grow, and over the next five years for sure.

I believe management in this respect since 2023 saw a $200m capex increase for new satellites (which I consider a growth investment) and a $100m increase in music royalties (which SiriusXM can usually recover by raising subscription fees, albeit with a lag), alongside other smaller investments. The company stated on its Q4/22 call that satellite capex will moderate already in late 2024 and shrink to near zero in 2027, where it will stay for many years.

In Q3/23 SiriusXM guided to $1.15B of FCF for 2023. Excluding 75% of the satellite capex and the one-off increase in music royalties, its steady-state capex should be roughly $250m lower, which means it needs very little growth to deliver the $1.5B of FCF which I expect in 2025 or 2026 at the latest.

In summary, if SiriusXM trades for a reasonable FCF multiple for a slowly growing subscription business with enviable assets, Liberty shareholders will do great in a very short timeframe. And even if SIRI slumps, Liberty shareholders would still not lose much or even gain a little.

And even if I am missing something, I certainly am not missing one safety backstop: Besides serving an attractive, rather affluent customer population, SiriusXM owns a piece of exclusive real estate in 80% (and growing) of all U.S. cars on the road with the possibility to receive audio and video via its own satellites – how could that not be an attractive acquisition target for a tech business seeking to expand into automobiles?

Editor’s Note: This article was submitted as part of Seeking Alpha’s Top 2024 Long/Short competition, which runs through December 31. With cash prizes, this competition — open to all contributors — is one you don’t want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!

Analyst’s Disclosure: I/we have a beneficial long position in the shares of LSXMA, BRK.B either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Buy Liberty SiriusXM As It Merges With Sirius XM For 50% Near-Term Upside appeared first on Up2info.com.

• I reiterate hold rating for SIRI due to weak growth drivers and subscriber trends.
• The New Generation app has potential, but I prefer to wait for actual results before evaluating its impact.
• I reduced my target price for SIRI based on subdued growth assumptions and valuation multiples.

Summary

Following my coverage on Sirius XM Holdings Inc. (NASDAQ:SIRI), which I recommended a hold rating due to my expectation that SIRI is unlikely to convert more subscribers despite the positive auto outlook for FY23. This post is to provide an update on my thoughts on the business and stock. I am reiterating my hold rating for SIRI as I hold a pessimistic outlook for the near term, especially with the key growth drivers being weak. The reason I am not downgrading to a sell rating is because of the potential impact of the New Generation app. I do see potential with it; however, I am not inclined to model in all the upside, as I prefer to wait for actual results before evaluating how impactful it is.

Investment thesis

In the recent 3Q23, SIRI reported consolidated revenue of $2.271 billion, driven by $1.729 billion in subscriber revenue, $460 million in advertising revenue, $49 million in Equipment revenue, and $33 million in music royalty fees and other revenue. Collectively, the $2.271 billion was down by a modest 0.4% vs. 3Q22. The flattish revenue was met with an increase in adjusted EBITDA. Adjusted EBITDA improved by 3.8% to $747 million, implying a margin of 32.8%.

The focus of the result was weak subscriber performance, which was my main concern. In 3Q23, SIRI saw a churn of 96k self-pay net losses and 94k subscriber net losses. This was a horrible performance when compared to 3Q22, where SIRI saw a net subscriber add of 138k. This quarter’s results have cemented my view that SIRI is facing a structural issue with its ability to add subscribers. Specifically, from a cost-to-value perspective.

The absence of a rebound in SIRI’s conversion rate suggests that the company may be reaching a juncture where the perceived value of their offerings in relation to the cost incurred by consumers is diminishing. Jay Capital SIRI 2Q23 update

SIRI appears to be stuck in a tough situation where it is unable to raise prices to cushion further subscriber losses. In the ideal environment, SIRI could have raised prices to continue supporting its growth. However, there are two key issues that I expect will continue to put pressure on ARPU growth in the near term. The first issue is that SIRI is going to continue facing the pain of the mix shift towards self-pay promotional and paid promotional plans (led by the increase in vehicle inventory that is on trial), which typically have lower ARPU. The second issue relates to the core issue I see with SIRI: its deteriorating cost-to-value proposition that consumers are perceiving, as evident from the sequential increase in subscriber churn rate to 1.79% (from 1.57%). Further increases in prices without any additions in value (more on this below regarding the Next Generation version) would simply cause churn to rise even further.

We benefited from a March price increase on select full-price plans and saw headwinds to reported ARPU from promotional self-pay subscription plans, the lowering advertising revenues I mentioned and lower paid promotional plan rates from certain OEMs, as well as higher balances on paid trials, subs and unsold vehicle inventory. 3Q23 earnings results call

The knock-on implication of a weak subscriber base is that SIRI advertising revenue will be negatively impacted. In my view, SIRI’s ability to capture more advertising budget is tied to the overall advertising spend environment (impacted by macro conditions) and the size of SIRI’s subscribers. Advertisers are likely to pay more if there are more subscribers (i.e., a larger audience). Based on the 3Q23 results, I know that the subscriber growth trend is not doing well. This, coupled with management’s comment that the overall ad market remains soft, led me to believe that the SIRI advertising segment is going to face pressure as well. Notably, on the call, management also noted that progress on the recovery in advertising in 2023 has not materialized at the level previously expected.

Overall, the key takeaways I have from the recent performance are that the subscriber growth trend continues to be weak, pricing is going to face pressure in the near term, and advertising is going to be weak as well. Put together, it paints a gloomy outlook for SIRI, in my opinion.

The only positive update that I see for SIRI is the announcement of its new Next Generation app and user experience, which will begin rolling out on December 14. This could be the solution to the core issue that, I believe, SIRI is facing (cost-to-value proposition). During the 2023 Liberty Media Investor Day, several key enhancements were made, namely:

1. Better pricing.
2. New manufacturer agreements and partnerships.
3. New content.

Looking at this from a positive lens, I believe that these enhancements and content additions may enable SIRI to regain subscribers and differentiate itself from other audio services like Spotify, Apple Music, and YouTube Music.

In terms of pricing, SIRI has announced a new, lower streaming price point: $9.99 per month for all of its content. Since the reduced pricing resolves the cost-to-value issue-which was one of my concerns with the SIRI product-I believe this will work and attract subscribers.

As for new manufacturer agreements and partnerships, management announced that the company has renewed and expanded its agreements with three major automakers-Honda, Mercedes-Benz, and Volvo-all of which have pledged to incorporate 360L into their vehicles. Additionally, it was announced that SIRI is nearing the finalization of new multi-year contracts with Audi and Volkswagen. Two other major EV manufacturers are also expected to make significant announcements about their 2024 launches with SiriusXM in the coming weeks. As for existing EV agreements, SIRI already has an agreement with Polestar to include 360L as a standard feature for their models. This is obviously good news for SIRI, as it means that the business can continue to distribute its product. More importantly, from an investor perspective, this, in a way, might be an indication that OEMs are seeing demand from consumers that they want SIRI. As for partnerships, progress was made as well. For instance, SiriusXM will be available at select properties in the Hilton portfolio and Amazon’s Audible. While I don’t see anything major that will move the needle in the near term, It was great knowing that management is attempting to shift out of the automobile ecosystem to find more users of its product, which might help extend the long-term growth runway.

Finally, regarding new content, the management focus seems to be on human-curated content. In the event, some of the introduced content includes The Kelly Clarkson Connection, The Highway, and This Life of Mine with James Corden. I don’t have an explicit view of how impactful this content will be. However, I do note the growing demand for podcasts. According to Statista, the number of podcast listeners has grown by almost 1.7x since 2019. The introduction of such content might be a driver for subscriber growth.

Overall, my take is that while we believe that these enhancements may help SIRI sustain positive subscriber and revenue growth in the coming years, it is premature to underwrite a material acceleration in those metrics before seeing signs of robust consumer adoption of Sirius XM’s new digital service today.

Valuation

My target price for SIRI based on my model is $3.47, a reduction from my previous price target of $4.35. The changes to my model assumptions are that I now expect growth to be flat in FY24 as I hold a more pessimistic view of near-term performance. All the key growth drivers (subs growth, ARPU, and advertising) were weak in 3Q23, and I do not see any solid catalyst that will drive them up in the near term. Some would argue that the New Generation app is the catalyst, but while true, I prefer to be conservative and wait for the actual results before evaluating. Putting aside the potential for the New Generation app, at the current status, I am revising (previously at 2.8x forward revenue) my view on what multiple SIRI should trade at given my weaker expected growth. I am now valuing SIRI using its trough multiple of 2.5x forward revenue.

Risk

The risk to my hold rating is that the New Generation app works like a wonder, driving sub and ARPU growth. If so, revenue should accelerate, and bearish investors (like myself) will be inclined to believe that the new strategy is working. In addition, a recovery in macro conditions would also boost further car sales and advertising spend, both of which are very positive for SIRI.

Conclusion

Overall, I reiterate my hold rating due to a pessimistic near-term outlook, marked by weak growth drivers and concerning subscriber trends. The headwinds from promotional plans also impede ARPU growth. Notably, the weak subscriber base forecasts a dampened advertising revenue potential. While the New Generation app has potential, my conservative stance holds until concrete results validate its impact.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Sirius XM Holdings: Weak Near-Term Outlook, But New Generation App Looks Promising appeared first on Up2info.com.

• Liberty Global proposes a risky transaction with Sirius XM Holdings Inc., which could negatively impact Sirius XM shareholders.
• Liberty Media currently owns 83% of Sirius XM Holdings, and the proposed merger would dilute existing shareholders’ ownership.
• Increased liquidity from the transaction could lead to significant selling and a potential decline in share prices for Sirius XM Holdings Inc.

On Tuesday morning, The Liberty SiriusXM Group (LSXMA) announced a proposed transaction with Sirius XM Holdings Inc. (NASDAQ:SIRI). SIRI investors need to be careful about this transaction. While M&A is usually good news for the acquired company, this deal looks to be a risky proposition for SIRI investors, though likely a good one for LSXMA holders. However, I suspect this story is still in its early innings. For now, SIRI shares are down 5% on the news, following what has been a rough year while LSXMA shares are up 5%. I see further risk in SIRI.

Currently, Liberty Media owns 83% of the common stock of SIRI. All other investors in SIRI control just 17% of the satellite radio company. Essentially, Liberty is proposing to create a new entity into which it will place its shares of Sirius XM, alongside debt associated with them, and it will spin this entity out to shareholders of Liberty and combine it with Sirius XM. Right now, an owner of Liberty Media owns shares in a media conglomerate with wide-ranging interests. Many conglomerates trade at discount valuations as investors only like certain pieces of the business. This would make remaining Liberty simpler and give its shareholders the option to sell their stake in Sirius XM by selling the shares they receive in the Spinco, if they are negative on the business.

After this transaction, existing SIRI shareholders will own about 16% of the company, so the terms of the merger are actually slightly dilutive to SIRI shareholders. Now, SIRI shareholders do get a $0.55 cash payout, but this merely compensates them for the net debt the company is adding as part of this transaction, and this cash payout may be taxable. Some investors may be happy to trade debt on the balance for cash in their pocket, but this is fundamentally a value-neutral exchange.

This is why Liberty, in its press release, does not highlight a premium for SIRI as a rationale for the deal but rather that it creates value via “enhanced trading dynamics, including increased liquidity and likelihood of future index inclusion.” As SIRI would no longer be a “controlled company,” it could eventually be added to indices over time. However, I would question whether increased liquidity is inherently a good thing. When Liberty Media shareholders receive their shares in the new Sirius, you may see significant selling because these investors now have much more liquidity in their stakes. While Liberty itself holds the entire 83% stake, it has tax considerations, and to the extent it sells shares, it is incentivized to do so in an orderly fashion to keep the share price up.

When the shares are distributed, that coordination around sales disappears. Indeed, if you receive shares and fear others will sell, you are incentivized to do so quickly, creating a “prisoner’s dilemma.” This is why spin-outs quite often trade poorly in the first days and weeks after the spin, as some investors receive shares in an entity they do not care for. AT&T’s (T) spin-off of its shares of Warner Bros. Discovery (WBD) to its shareholders is a good example of this risk.

Ultimately, this increased liquidity and forced-selling risk is a reason why existing SIRI shareholders should demand a premium to protect themselves from this-for instance, they should own 20% of the combined company, up from 17% currently. Instead, they are receiving a discount in practice, while facing this downside risk. As long as this proposed transaction is up for debate, I expect it will be an overhang for shares.

SiriusXM is creating a special committee of its board to evaluate the proposal, and in my view, they should reject it. Currently, Liberty shareholders win. Liberty is simplifying its business, they have the liquidity to sell their pro-rata stake in SIRI, and they receive a slight premium. SIRI shareholders will likely end up footing the bill for this via a lower stock price.

Even with shares down, the stock is trading at about 14x free cash flow guidance of $1.15 billion. For a company with minimal growth (revenue was flat year over year last quarter), amid competition from steaming and podcasts, this is a reasonably full multiple that does not suggest shares are fully pricing in the risk I see.

With this transaction posing a significant risk and likely to be a persistent overhang, I would be careful of shares here and recommend selling. I would want to see shares down 15-20% to compensate for the risk that 80+% of the float may soon become available to sell, or wait for shares to fall below $3.40 before entering. For now, risks are skewed to the downside and investors should avoid SIRI.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Sirius XM Shareholders Should Be Wary Of Liberty’s Proposed Merger appeared first on Up2info.com.

• I reiterate a hold rating due to my expectation for continuous weak conversion rates, driven by price sensitive consumers and competitive pressure.
• 2Q23 results continued to show disappointing self-pay net adds and ARPU, although advertising revenues exceeded expectations.
• My model indicates that the current share price is around fair value.

Summary

Following my previous coverage on Sirius XM Holdings (NASDAQ:SIRI), I recommended a hold rating due to my expectation that the outlook is going to be bleak given the limited opportunity for SIRI to grow revenue in this weak auto market driven by high rates, weak conversion rates, and an uncertain advertising backdrop. This post is to provide an update on my thoughts on the business and stock. I continue to recommend a hold rating for the stock as I believe SIRI is not in the best position to continue converting more subs despite the positive auto outlook for FY23. In addition, my valuation model suggests the stock is fairly valued.

Investment thesis

I still find SIRI’s 2Q23 results disappointing in terms of self-pay net adds and ARPU, despite the fact that they were slightly better than consensus expectations for revenue and adjusted EBITDA. The earnings report revealed a notable positive aspect, namely the performance of advertising revenues, which exceeded my expectations. This was primarily driven by a higher-than-anticipated growth in Ad revenue per impression, reaching $97.13, which can be attributed to a stronger advertising market. The outperformance of adjusted EBITDA can be attributed to a combination of surpassing revenue expectations and a decrease in sales and marketing expenses, which the company has proactively reduced in anticipation of its upcoming product launch scheduled for later this year.

While my bearish view on the advertising outlook has turned slightly better given 2Q23 performance, the other two negative factors I mentioned previously remain a concern of mine: (1) being unable to grow revenue in this weak auto market (i.e., net adds are going to be weak); and (2) weak conversion rates.

In relation to the first point, it is noteworthy that SIRI, as anticipated, reported self-paid net additions in the second quarter of 2023 that were below expectations. This was accompanied by a churn of 133,000 self-pay subscribers (self-pay churn rate was recorded at 1.54%). During the conference call, the management expressed their anticipation of observing a modest increase in self-pay net additions during the latter half of the year. Furthermore, they expect to witness a gradual improvement in this regard as the year progresses. It is worth noting that management had previously indicated its anticipation of a modestly negative increase in self-pay net additions for the year 2023. From my perspective, it can be argued that there is a certain degree of validity to the management’s outlook, given that the projected sales of light vehicles in the United States seem to be surpassing what I would have expected given the prevailing high interest rates. Although there is a positive trend in auto sales, it is important to highlight to readers that an increase in auto sales does not necessarily guarantee a corresponding increase in SIRI’s revenue. It just means there are more opportunities for conversion.

This leads to the subsequent point regarding conversion. According to the management’s statement, the conversion rates have exhibited stability, implying that they have consistently remained within the low-30%s range for new cars and the low-20%s range for used cars. These figures indicate a deviation from historical patterns (high 20s to 30s% for used cars and high 30s to low 40s% for new cars). The absence of a rebound in SIRI’s conversion rate suggests that the company may be reaching a juncture where the perceived value of their offerings in relation to the cost incurred by consumers is diminishing. In my opinion, conversion rates have dropped as SIRI has gotten more ingrained in the auto base and begun focusing on the more price-sensitive customers. The aforementioned phenomenon, coupled with intensified competition in the realm of high-quality audio services, specifically in the domain of streaming, will persistently exert influence on the process of conversion. Management expresses optimism regarding the potential conversion benefits associated with initiatives such as 360L. However, I maintain a concern regarding the heightened competitive intensity within the premium audio sector and the increased availability of applications in the dashboard, both of which may exert pressure on subscriber trends.

The clearest signal of the competitive environment can be seen in the ARPU metric. SIRI recently disclosed an ARPU of $15.66, and this figure shows only slight fluctuations compared to the previous year, even though they raised prices on certain full-price plans in March. I believe that, in the coming year, Sirius XM may face constraints in its ability to increase prices and ARPU due to macroeconomic conditions and strong competition. It is probable that Sirius XM will have to maintain discounts to appeal to cost-conscious consumers.

Valuation

I believe the fair value for SIRI based on my model is $4.35. My model assumptions are that growth will basically be muted for FY23 given all the negative headwinds and also just as management guided. FY24 will see a growth acceleration to 4% given the easy comps in FY23, but decelerate back to 1% (using the consensus estimate). My take is that SIRI will no longer see historical growth given the saturation of its target consumers and increasing competition.

As Spotify (SPOT) is not generating meaningful profits, I used a revenue multiple to compare peers. SIRI is currently trading at 2.8x forward revenue, which is a premium to its peers. This gap exists likely because SIRI is the most profitable player among the group and is still showing positive growth so far. I expect this gap to remain for the foreseeable future. Peers include Spotify and IHeartMedia (IHRT). The average forward revenue multiple peers are trading at is 2, and the average EBITDA margin between them is 8%, which is way lower than SIRI.

Conclusion

Despite a positive performance in advertising revenues and the anticipation of increased self-pay net additions in the latter half of 2023, SIRI faces significant challenges. The stability in conversion rates at lower levels compared to historical patterns suggests diminishing perceived value among consumers. Additionally, heightened competition in the premium audio sector and the availability of dashboard applications may further impact subscriber trends. The ARPU metric remains a crucial indicator of SIRI’s competitive environment, with limited ARPU growth despite price increases. In the upcoming year, economic conditions and strong competition may constrain SIRI’s ability to raise prices, likely necessitating discounts to attract cost-conscious consumers, in my view.

Overall, I maintain my hold rating on SIRI, as the company faces ongoing challenges in a dynamic market landscape.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Sirius XM Holdings: Outlook Remains Bleak As Conversion Rate Is Still Low appeared first on Up2info.com.

• Sirius XM Holdings Inc. is recommended for a Sell rating due to an uncertain future coupled with overvaluation built up recently due to short squeeze.
• The company’s stock rallied by 113.4% in the month leading up to July 20, but fell significantly on July 21 due to analysts downgrading their recommendation ratings.
• Sirius XM’s Q1 2023 results showed a 2.3% year-over-year revenue decline to $2.14 billion, and a decrease in free cash flow by 44.2% year over year to $144 million.
• The short squeeze has decoupled stock prices from fundamentals, shares are technically very high, high short-term interest rates are bearish this time.
• The outlook is not suitable for driving the company’s growth.

A Switch from Buy to Sell for Sirius XM Holdings Inc.

In the previous article, a Buy recommendation was given to the stock of Sirius XM Holdings Inc. (NASDAQ:SIRI) – a New York-based audio entertainment operator in the United States. The previous rating was supported by the expectation of an increase in the share price amid a more favourable outlook with people showing greater interest in the company’s various audio content products.

As it faces a very uncertain future, this stock is unlikely to thrive, so the retail investor should consider easing the position by selling shares of SIRI while taking advantage of the strong valuation SIRI has recently built up. This article is therefore for a Sell recommendation rating.

What Happened to the Stock in SIRI in the Meantime

SIRI had a great rally, gaining 113.4% in the month leading up to July 20, when shares hit $7.81 apiece, albeit for different reasons than those that supported the previous Buy rating. In fact, analysts attribute the rally to a short squeeze at a very small float that forced the stock price to rise very quickly.

On July 21, SIRI stock price fell significantly, losing 9.35% to an adjusted closing price of $7.08 per share as some analysts downgraded their recommendation ratings to a Sell rating before the market opened, as the current valuation is not warranted by the company’s fundamentals.

Before the big rally, SIRI had a very disappointing performance in the stock market, particularly in the new year, likely due to the deterioration in certain economic conditions as rising costs of living prompted people to make decisions including cutting their entertainment spending. These macroeconomic factors may not yet have fully impacted the company’s fundamentals, so the downward trend in revenue and company profitability seen in the first quarter of 2023 results could continue in the coming quarters. However, concerns about the impact that high inflation and tight monetary policy on consumption and investment could have on SIRI’s business was enough to push the stock down very sharply until last month’s rally due to the aforementioned technical factors.

Eventually, these severely depressing headwinds for equities also affected Netflix, Inc. (NFLX), whose stock price seemed to have taken a major tumble at a certain point. And in my opinion if it weren’t for a bit of artificial intelligence propaganda lately shaping the narrative in financial markets, NFLX would still be well below pre-pandemic levels.

And if it happened to a digital entertainment leader like NFLX to lose ground to a fall in subscriptions, why couldn’t SIRI also take the toll of lower consumer purchasing power for higher inflation and higher debt? Looking at the company’s Q1 2023 results, SIRI seems to be taking its toll.

The Seeking Alpha chart below shows the trends SIRI and NFLX have taken in the US stock market.

As such, last month’s rally allowed SIRI stock to recover from the lag it developed compared to the rest of the stock market (US 500 is the benchmark index on the Investing.com chart).

Technical factors have propelled shares of SIRI higher as the rising artificial intelligence narrative has been positive for NFLX and tech stocks in general.

This market valuation now appears to be a godsend based on a number of technical and fundamental analyses, coupled with an outlook that promises stronger headwinds for stocks, including SIRI. So the retail investors, whether it is the case, might consider taking advantage of these valuations that have come about and selling shares.

The Stock Valuation

Shares of Sirius XM Holdings Inc. traded at $7.08 apiece as of this writing giving it a market cap of $27.39 billion.

As shown by below chart from Seeking Alpha, shares are now trading significantly above the 20-day simple moving average line of $4.93, above the 100-day simple moving average line of $4, and above the 50-day simple moving average line of $4.15.

Shares are also trading at a 79.6% discount to the middle point of $5.635 of the 52-week range of $$3.32 to $7.95.

So these are market valuations for the SIRI stock that were unthinkable until a few weeks ago, even from a fundamental analysis point of view.

Indices of Fundamental Analysis in Comparisons

In the first quarter of 2023, SIRI reported a 2.3% year-over-year revenue decline to $2.14 billion, missing median projection of analysts by $30 million as a) a lower average revenue per user [ARPU] of $15.29 caused a 2% year-over-year decline in SiriusXM business segment revenue to $1.7 billion and b) a 2% decrease in self-pay subscribers led to a year-on-year revenue decrease of 1% in the Pandora and Off-Platform business segment to $4 62 million.

As such, the company’s total 12-month revenue for the first quarter of 2023 was $8.961 billion which, when combined with the stock’s current market valuation, results in a price-to-sales [TTM] ratio of 3.08x versus the industry median of 1.22x. Additionally, SIRI’s revenue grew slower year-over-year than the industry average: 1.55% versus 4.92%.

SIRI’s revenue growth of 1.55% year-over-year is well below SIRI’s 5-year average of 11.44%, while the share price is currently one of the highest in the past 5 years.

Going forward, the context for SIRI will likely be at least as challenging as it is today. Interest rate hikes will continue to negatively impact consumer purchasing power, as will stubborn core inflation. It’s reasonable to still expect negative pressure on ARPU and subscriptions.

SIRI is judged to be overvalued compared to many other entertainment stocks based on past sales. The valuation based on forward sales does not have a different outcome at these share prices and expected prospects of the economy.

Assuming SIRI’s most recent TTM revenue will grow 2.17% to $9.16 billion (vs. company’s guidance of $9 billion) or $2.37 per share in the first quarter of 2024 (assuming that the amount of shares outstanding of 3.87 billion will not change), at current share prices, the Price to Sales Ratio [FWD] should then be approximately 3. But this metric still does not compare favorably to a sector median of 1.21 and SIRI 5Y average of 3.18%.

The Profitability of the Company and its Evaluation

The key component impacting free cash flow, which decreased 44.2% year over year to $144 million in the first quarter of 2023, was a 9% decrease in Adjusted EBITDA to $625 million in the first quarter of 2023 versus $690 million in the first quarter of 2022.

The adjusted EBITDA margin was 29.2% of total consolidated revenue in Q1 2023 versus 31.6% in Q1 2022, or a 240 basis points drop YoY.

On a 12-month basis, SIRI’s EBITDA margin was 28.69%, compared to the industry median of 18.08% and compared to the SIRI 5-year average of 30.64%.

SIRI has EV/EBITDA [TTM] of 14.47x versus industry median of 9.59x and versus SIRI 5Y average of 14.43x.

Profitability Going Forward

Looking ahead to full year 2023, SIRI is targeting adjusted EBITDA of $2.75 billion and free cash flow of $1.1 billion.

Looking ahead, SIRI’s EBITDA is expected to grow by 0.44% compared to the industry average of 4.69% and compared to SIRI’s 5-year average of 4.76%. This leads to SIRI’s EV/EBITDA [FWD] of 13.53x versus industry median of 8.37x and versus SIRI 5Y average of 13.32x.

However, despite lower free cash flow, the company was able to return approximately $161 million to shareholders in the first quarter of 2023, 58.4% of which by paying dividends and the remainder by repurchasing its own shares.

The company paid a very small quarterly dividend of $0.024 per share on May 24, resulting in a forward yield of 1.37%, below the S&P 500 yield of 1.51% as of this writing.

Due to a challenging outlook, SIRI’s sales and profitability could suffer a bit further going forward, potentially creating a negative impact on the stock price.

Oversold Levels and High Short Interest Rate

Shares already seem to be feeling the pressure of bearish sentiment, as the indicators below show, meaning that the positive trend of the past month is unlikely to continue.

A high Short Interest reading of 33.72% does not mean that another short squeeze could push the price higher, but rather suggests that there is clearly bearish sentiment towards this stock at the moment.

The 14-day relative strength indicator of 76.75 shows that shares of SIRI are near oversold levels with very, very little room for going higher.

Conclusion

The very enthusiastic short selling activity in SIRI shares created a counter effect to the expected pessimistic sentiment that stimulated investors, resulting in a very rapid increase in the share price.

This stock is characterized by a small float of 16.81% of the total number of the shares outstanding of 3.87 billion (on this page, scroll down to the “Ownership” section), and 72.52% of this float is held by institutions.

So for those retail investors who may have shares of SIRI in their portfolio and the sale of shares does not cause them a loss, they should consider selling and taking advantage of these price levels.

Given the high volatility that characterizes the economy and which does not help companies, including SIRI, to boost growth, there is a risk of having to wait a while for these prices to return.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Sirius XM Holdings: Short Squeeze, Prices Soared, Now What? (Rating Downgrade) appeared first on Up2info.com.

• The short Sirius XM Holdings Inc./long The Liberty SiriusXM Group NAV discount arbitrage has been a popular trade.
• However, some fund managers have probably been too greedy and ended up in a massive short-squeeze.
• Here is what might come next and how you can still profit from the situation.

The short Sirius XM/long Liberty SiriusXM Group arbitrage

Everybody and his grandma have been aware of the large NAV discount weighing on The Liberty SiriusXM Group (NASDAQ:LSXMA, NASDAQ:LSXMK, NASDAQ:LSXMB) tracking stocks, which usually traded 25-30% below the sum of their market traded assets: an 83% stake in Sirius XM Holdings Inc. (NASDAQ:SIRI) and a 27% stake in Live Nation Entertainment, Inc. (LYV).

This is why the smartest guys came up with an easy arbitrage: Go long the Liberty tracker and hedge business risk by shorting Sirius XM Holdings. Even if SiriusXM went bankrupt, thanks to the pre-existing NAV discount, such a trade should be profitable.

The problem with this arbitrage was that it was just too popular: given the small float of only 17% of SIRI stock, corresponding to about 660 million shares (much of which are likely also owned by long-term shareholders and therefore not available for trading), the recent short interest of about 220 million shares coupled with an average trading volume of just ~20 million shares looks frightening.

Front-running the arbitrage unwind

We know that at the beginning of August, Liberty SiriusXM will split into a pure-play tracker based on only its SIRI ownership and another tracker based mainly on the Live Nation stake. Management has been quite open about the reason for the split: in some way, the move will pave the way for a merger with SiriusXM – which obviously should finally collapse the NAV discount.

More details on the transaction and its implications on the NAV discount can be found in my article from last December.

Since all this has not been a secret, some investors thought the smart thing to do was to unwind the hedge before others did. Hence, they bought back the borrowed SIRI stock and closed their short position, maintaining only the long Liberty SiriusXM position.

This is why in recent weeks SIRI has greatly outperformed its Liberty tracker:

Being late to the party and getting squeezed

Those that were late to realize the risk of a short squeeze were caught flatfooted yesterday, as Barron’s explained what was going on, basically calling in reinforcements. Many traders that were not at all interested in the arbitrage jumped on the opportunity and bought call options on SIRI, which required market makers to buy the stock, thus exacerbating the situation further and creating a self-reinforcing vicious cycle. Investors that had believed in a normally priced opportunity to close their SIRI short, found themselves heavily underwater, and every second the stock climbed higher and higher, triggering several trading halts on its way.

Expectations for today and beyond

Since the start of July 2023, when 220 million SIRI shares were still sold short, roughly twice as many SIRI shares have been traded. While it is possible that the entire short position has been closed, it is not likely, as just yesterday 126 million shares changed hands (6-8 times the normal trading volume), many of which were bought by market makers, short-term traders or others. So at least some of the massive short position is still waiting to be covered.

However, analysts are giving their helping hands, downgrading SIRI before the open and sending the stock a bit lower. This means that some of the holdouts may get a chance to cover without needing to chase the bid.

Overall, my best guess is that the squeeze won’t move much higher. This short covering trade had been going on for quite some time without being noticed too much.

We would need to see some massive retail speculation similar to the GameStop Corp. (GME) mania to push prices further to the moon. While this remains a possibility, so far it has not happened.

How you can still profit

If you feel sure enough that fundamentals will take SIRI back down from its current price of $7.80, you can short SIRI, although I would not recommend such a gamble.

On the other hand, the Liberty SiriusXM tracker still remains very cheap. Those buying today LSXMK for $34.50, within a few weeks should receive a pure-play SiriusXM tracker, and for every four shares they own, another share of the new Live Nation tracker, for an underlying total value north of $80.

Sure, SiriusXM is quite richly valued today. If it comes down to its old trading range, we should expect the Liberty tracker’s NAV to shrink a bit in the meantime. Yet even if we assume that SIRI will come back down to $6, the underlying value of today’s LSXMK is still about $75. You can buy it for less than half of that, and the catalyst that should finally shrink the NAV discount is likely to materialize within less than one year.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of LSXMK either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Liberty SiriusXM: Even More Attractive After The Sirius XM Holdings Short Squeeze appeared first on Up2info.com.

• Sirius XM faces increasing competition and changing technology, but its unique content and loyal customer base provide a fighting chance.
• The company is transitioning to non-linear audio streaming to appeal to younger listeners and stay relevant in the evolving market.
• Sirius XM’s valuation is considered fair, and its stable cash flows could be better utilised through buybacks at Liberty Sirius XM.

Sirius XM (NASDAQ:SIRI) is one of the US’s largest subscription-based audio entertainment platforms. The company has been dominating the highly profitable in-car satellite radio segment, unfortunately, the satellite is no longer the only method to deliver premium audio content to subscribers on the move. The moat of Sirius XM is shrinking and Company is expected to deliver its first-ever net subscriber losses this year.

Given the slower growth expectations, SIRI stock re-valued to 9.6X EV/EBITDA, down from an average of c15X over the past 5 years. This valuation level could arouse investor interest, though we have to keep in mind that the competitive environment has changed significantly over those 5 years. Indeed, if SIRI continues losing customers it could potentially re-rate to a declining traditional media status. The members of this group, such as terrestrial radio stations, commonly trade at a 5-6X EV/EBITDA. Re-rating would result in a further c50% SIRI share price drop.

Sirius XM has actually continued performing well even after online music streaming services entered the in-vehicle market. Currently, Sirius is a profitable and cash-generative business capable of paying out a generous dividend. We want to find out if they can continue maintaining their strong position going forward.

Background

The satellite radio services of Sirius were launched in 2001. Back in those days Nokia 3310 was still the most popular phone and nobody has ever dreamed of being able to stream huge music libraries over mobile networks on demand. Satellite was the premium alternative to terrestrial radio, offering commercial-free listening and superior sound quality.

The satellite radio industry took off in a significant way in 2008, after Sirius has been allowed to merge with its main competitor XM. Consolidation enabled cost rationalisation as well as pricing discipline and therefore a larger share of gross profits started being invested in exclusive premium content, attracting an increasing number of customers to take on a subscription. Sirius XM subscriber numbers have doubled and Average Revenue Per User (ARPU) has increased 50% since then. By all accounts, the business has prospered.

The next significant turning point of the industry came in about 2010 when the first major 4G/LTE networks were launched in the US. On-demand streaming services have launched mobile apps and their subscription rates started rocketing. Spotify subscriber numbers, for example, have increased from c1m in 2010 to c205 million now. It is the largest subscription audio platform globally and in the US.

Streamers have pushed commercial terrestrial radio stations to the brink of extinction. Sirius XM, on the other hand, has held up and managed to grow, but it is possible that satellite radio is next in line. Only in 2017, all major carriers launched unlimited wireless data plans. Music streamers have been around for a number of years prior, but it was the rollout of 4G and the reduced cost of wireless data that has enables truly mobile music streaming. Nowadays streamers are increasingly penetrating in-car displays and infotainment systems – the distribution pipe has been commoditised and competition for satellite radio is increasing.

Sirius XM continues performing well

Actually, 2017 did not turn out to be a waterfall moment for Sirius XM, the Company continued to perform well. Over the past 5 years:

1. Self-pay subscribers grew from 26m to 32m (23%)
2. ARPU has increased from $13.3 to $15.6 (17%)
3. Satellite radio revenues increased from $5.4 bn to $6.9 bn (28%)
4. Churn has gone down from 1.8% to 1.5%

We believe this solid performance in an adverse market can be attributed to distribution gains and differentiated content offerings. An increasing number of new vehicles are equipped with satellite radios and this gradually drags up rates of satellite radio penetration among remarked used vehicles. Sirius XM has been signing up new manufacturers and also expanded partnerships with used car dealerships. Going forward, the used car segment has a significant growth opportunity, and new car penetration will also increase further. Increasing penetration would not be possible without a strong content package as automakers would not be installing the satellite radios if their customers did not see any value from them.

Click to enlarge

Sirius XM Financial statement, earnings transcripts and our estimates

Increasing penetration in new and used vehicles has been increasing gross additions even as conversion rates in new cars have been falling. Sirius XM explains that the decline in conversion rate is due to range expansion to the economy segment, which is a lot less likely to subscribe to SXM. Competition from streamers also has been a factor but it is hard to isolate the impact of this factor alone without having the track record of conversion rates of specific car models. All we can do is just follow the development of conversion rates.

Siri is now claiming that conversion rates are likely to go down for 2023 both in the new and used car segments. If this lower rate is sustained going forward, churn and gross additions could get close to one another for some time. The penetration rates will continue to increase, so if a lower level of conversion is maintained, then at some point net adds are likely to turn positive. It is a balancing game between declining conversion and increasing penetration.

Overall, it seems highly likely that:

1. New car subscriber additions will be in excess of 4.3M or so in a normalised economic environment.
2. Used car subscriber additions are likely to be in excess of 2.5m per annum and most likely will grow their share of overall gross additions.
3. Annual churn will most likely be at least 6.5, depending on churn rates and the size of the subscriber base.
4. Most likely subscriber base will grow over time but not by significant numbers, maybe by 0.3-0.7m per annum or c1.5%.
5. A sudden decline in consumer numbers by numbers in excess of 1 million (3%) seems very unlikely unless churn rates jump meaningfully.

Pricing is another factor to consider. So far ARPU was climbing and in 2023 Sirius XM is pushing through another price increase. Satellite radio packages are indeed more expensive than Spotify SPOT or Apple Music subscriptions, on the other hand, these are not directly comparable products both in terms of content offered and technology. Satellite radio might be more expensive but it does not require an additional subscription to an unlimited wireless data plan. SXM streaming-only product is priced in line with other streamers. We do not see large scope to increase ARPU in satellite (on-platform) business, at the same time we do not believe that SIRI is facing significant pricing pressures. SIRI might face some pricing challenges when satellite ratio technology becomes obsolete, but we are not there yet.

Overall, subscriber numbers of Sirius XM seem to be driven by multiyear new and used car penetration growth trends, relatively low rates of churn and decreasing conversion. Penetration is increasing predictably, churn has been low for years and conversion has been trending down gradually. We believe it is very unlikely that Sirius XM would start losing customers rapidly. Having said, decelerating conversion is the best indicator of increasing competition for Sirius XM. The company has no control over the technological advances of the industry, therefore it has to focus on content to manage competitive threats.

Distribution pipe development – parallels with TV

Premium audio distribution pipe is being commoditised and an increasing number of competitors are now able to reach in-car listeners. Since the channel of distribution is no longer the differentiating factor, the content becomes increasingly important. The video content industry has gone through the same change, now audio is going through this as well.

In the TV industry, the initial step was also fragmentation based on consumer tastes. The few leading network TV channels continued losing audiences as technological advances made it possible to broadcast an increasing number of channels at an affordable price. These new channels catered to smaller customer groups and gradually kept taking viewers away from the incumbents. Then on-demand video streaming services entered the scene.

Cable TV did have the best content, but the new content consumption method has proven more appealing to consumers and streamers managed to build a sustainable business. TV media fragmentation has created a lot of complexity and the process of discovery has become increasingly complicated. Non-linear streaming with personalisation functionality in a way was the last step in the process of fragmentation. Now consumers were recommended what they most likely enjoy personally and they can watch it whenever they want, – a fully personalised experience.

The streamers have built their business on the back of the content distribution pipe innovation, but they could not have grown without good quality content. Initially, they licensed popular content. Once the scale was already acquired, Netflix NFLX was able to start creating its own content. And they have been successful at it. Pipe development was an industry-wide phenomenon and Netflix won because it had better content than other streamers.

Satellite radio is similar to a cable TV operator that is being challenged by video streaming services. The audio pipe is developing along the same route of personalisation and easier discovery. Sirius XM Platinum package, for example, has 425 channels… 425! It has everything that almost anybody could wish for, but once you get the bundle, how do you find exactly what you want? How do you make sure it plays exactly when you are driving home from work? The older customers of Sirius XM have probably gone through that tedious process of discovery as there were no alternatives, and they are happy to stick with the habits they formed.

The younger generation of listeners though has a lot more options and they are already used to getting whatever whenever, and Sirius XM does have lower conversion rates with the younger generation of drivers. To stay relevant, SIRI does need to get on the bandwagon of technological pipe development to have a chance to survive long term. The acquisition of Pandora in 2019 and the current roll-out of the next-generation 360L receivers are significant moves in that direction. The company has also launched a streaming-only app and is continuing to upgrade its tech stack to suit on-demand listening. These actions should help SIRI to increase its rates of conversion with younger listeners.

When it comes to competition in the non-linear audio space, the content will be the key. Quite interestingly, Sirius XM offers completely different audio content from the likes of Spotify or Apple Music. The streamers mainly enable listeners to reach broad music libraries of record labels directly from one app and they spend most of their revenues on music royalty payments. SIRI, on the other hand, is focused on internally produced and licensed original content. If SIRI would be an add-free premium music-only linear radio station they would probably be going out of business by now. This is not the case. Unlike the streamers, SIRI is offering live business news, events and sports, big-name talk shows and political commentary as well as a number of thematic music stations. We believe that the content bundle of SIRI is so differentiated and so much more valuable to some customer groups, that they are able to compete successfully even against superior distribution technology.

Overall, SIRI does have a superior content bundle as compared to the music streaming services but it is lagging behind technologically. Non-linear audio streaming is favoured by younger listeners and SIRI is gradually making a transition. Superior content is buying it time, but eventually, it will have to move to non-linear or hybrid content distribution.

Valuation

The price of Sirius XM has declined by 30% this year, it is currently trading at about 9.6X EV/EBITDA and c7-8% Free Cash Flow yield, – it’s an all-time low for Sirius and reflects slower subscriber growth. This level of valuation is common for mature media businesses that are not in decline.

We take a long-term defensive approach to investing and seek to double our money over a period of 3-5 years. Sirius XM does fit the bill of a defensive business, but we do not see how it could double its value over the next few years as the organic growth opportunities are limited. The current valuation multiples also seem appropriate given the reduced growth expectation. But there is another, more profitable way to invest in Sirius XM and we can double our money that way.

The Liberty SiriusXM Group (LSXMK), managed by Liberty Media, controls 83% of SIRI shares and trades at a significant discount to the value of its holdings. Combining the defensive 7-8% free cash flow at SIRI with the discount and extra level of leverage at the holding company level, – yields a c16% look-through free cash flow. The risk characteristics of SIRI and LSXMK are almost identical, so it does make more sense to own LSXMK instead. For more information on this investment thesis, you can read our article on Liberty Sirius XM.

Is it a good investment?

Sirius XM is a stable subscription-based business with low churn. The company is facing increasing competition but the unique content bundle as well as increasing penetration in new and used cars is helping the company to grow subscriber numbers. We believe that these trends are likely to continue even as content delivery technology evolves. We deem it very unlikely that Sirius XM will start losing subscribers rapidly and turn into a value trap.

Having said it, rapid growth is not very likely either as conversion rates will most likely continue trending down as competition in the in-vehicle segment will only intensify. We believe that the valuation of SIRI is more-less fair and therefore we suggest “Hold” for this stock.

We are not recommending a “Sell” because SIRI is a capital-light business and most of its free cash flow can be paid in dividends or returned through buybacks and the current yield is quite attractive given the defensive characteristics of the business. We are not recommending “Buy” because we pursue returns greater than 7-8% per annum. On the other hand, we are Buyers of Liberty Sirius XM.

Risks to the investment thesis

1. Subscriber growth of Sirius XM has been driven by the balance of increasing penetration and declining conversion. The penetration will keep on rising and the conversion rates will most likely continue trending down. A downward shift in conversion rates could push Sirius into a cycle of negative net subscriber additions. On the other hand, the losses would be only marginal as increasing penetration will support gross additions.
2. On-demand is gradually becoming the industry standard and linear streaming is not popular with younger consumers who have formed habits different from their parents. Sirius XM does have lower conversion rates with younger customers and if it is not able to deliver an appealing non-linear listening solution to them, – the conversion rate decline will accelerate. 360L is the next-generation player that Sirius is now rolling out and it combines linear with non-linear capabilities. The success of this platform is very important for the future of Sirius.
3. Going forward satellite radio technology could become obsolete and the ARPU of the business can start trending down towards the price of a premium streaming-only package price. So far there are no clear indication that customers would be cutting satellite subscriptions in favour of streaming-only products. Sirius is quite vague about streaming only customer numbers.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Sirius XM: Penetrating Through Difficult Times appeared first on Up2info.com.