With Chrysler filing for bankruptcy protection, and the news that they will be halting production for a period of up to two months, people may immediately assume that the news will be bad for Sirius XM Radio. Frankly, the Chrysler situation presents a mixed bag of news for satellite radio investors. There are a few stories out there that note the Chrysler news, but look at it as a pure negative. If you look deeper into how the mechanisms of these deals work, you may arrive at a differing conclusion. To better understand the discussion of this article, we request that you refer to our piece titled "Understanding The Metrics Of Sirius XM"
In their latest quarterly filing Sirius XM made a statement relating to the Chrysler situation:
"On April 30, 2009, Chrysler LLC filed for bankruptcy protection under Title 11 of the United States Code. Chrysler’s bankruptcy may have certain adverse effects on us, including:
• Chrysler has announced that it plans to idle its plants during the pendency of its bankruptcy case. We do not expect to generate a significant number of new subscribers from Chrysler while its plants are closed. During the year ended December 31, 2008, Chrysler produced approximately 900,000 vehicles which included a satellite radio and a prepaid subscription to our service. These subscribers represented approximately 16% of our gross subscriber additions in 2008.
• As part of its bankruptcy case, Chrysler may reject or assume its agreement with us. If Chrysler rejects our agreement, we could lose a significant source of future subscribers to our service, but we would be released from our obligations to Chrysler to share revenue, provide equipment subsidizes and make other payments. We do not have any reason to believe Chrysler will reject its agreement with us.
• Chrysler’s bankruptcy could also disrupt and/or delay the payment of certain amounts to us, particularly amounts owed to us by Chrysler on the date of the bankruptcy filing for subscriptions to our service.
There is also significant uncertainty surrounding General Motors’ future and potential filing for bankruptcy protection. A bankruptcy filing by General Motors could have similar effects on our subsidiary, XM. Specifically, a General Motors bankruptcy could reduce the number of subscribers we realize from General Motors, would allow General Motors to accept or reject its agreement with XM, and could disrupt and/or delay the payment of certain amounts to XM. Similarly, if General Motors rejected its agreement with XM, XM would be released from significant financial obligations to General Motors."
Okay. The company outlined the possible bad news. It is their responsibility to shareholders to do that. Is there possible good news in here though? That depends on your perspective, but I will outline potential impacts and let readers decide what metrics carry more importance. One reason I have been so ardent about understanding the subscriber metrics and more specifically, the OEM deals, is that Chrysler plays a major role in satellite radio. Bear in mind that if a similar event were to happen with GM, that the impacts would differ substantially because of the structures of the deals.
In order to understand the various impacts that will be a part of the current quarter, we need to first understand the Chrysler deal. In layman's terms, Sirius XM pays a subsidy to Chrysler to install a radio. The Chrysler deal hinges on Chrysler buying subscriptions and then bundling those subscriptions into their cars. Thus, upon manufacture, Chrysler pays Sirius XM Radio for a one year subscription. It is at this point that Sirius XM counts that radio as a promotional subscriber, and investors in the know a "parking lot subscriber".
While what has been stated so far seems trivial, let's look at how these events impact the metrics of Sirius XM:
- When Sirius XM pays a subsidy for the installation of a radio, there is a cost. This cost is reflected in the Subscriber Acquisition Cost metric of Sirius XM's books. If Chrysler is shutting down plants, there will be no such costs to Sirius XM. This will help improve the SAC metric. One possible exception is if the company shifts installations (at least in terms of numbers) to another OEM. If that is the case, then costs would once again exist.
- When Chrysler pays Sirius XM for a subscription, the money is booked in DEFERRED REVENUE. Deferred revenue is a liability. Chrysler is contracting for one years worth of service to the buyer of the car. Sirius XM is obligated to deliver that service. In some ways you can think of deferred revenue in this situation as an escrow. If Chrysler is shutting down production, they will obviously not be buying subscriptions. If they are not buying subscriptions, they will not be adding to the liability that is deferred revenue. In addition, during the time when the car is a "parking lot" subscriber, there is a negative impact on Average Revenue per User (ARPU). This is because the "parking lot subscriber" in effect contribute $0 in revenue to Sirius XM, yet is used in the calculation as a subscriber. "Parking lot subscribers" boost the subscriber roles, but carry a negative imp[act on ARPU.
- When a consumer buys a car, Sirius XM begins to shift dollars on a monthly basis from deferred revenue to revenue. In effect they are decreasing their liability line and increasing their revenue line. Chrysler has an existing inventory of about 80 to 90 days worth of cars. Some of these cars have satellite radio installed and are already being counted in the official "promotional subscribers" line and unofficial "parking lot subscribers" line. As the pool of "parking lot" subscribers decreases, the revenue line for Sirius XM will increase. As the deferred revenue from this pool shifts to revenue, the ARPU will increase.
The essence of what I am saying is that while the contributions to the subscriber pool supplied by Chrysler will decrease, there are going to be changes to Sirius XM metrics that will benefit from the halt in production. Investors should be cautious that there are many variables at play. Shifting installations to other OEM's could impact these offsets. A lot also depends on what manufacturer benefits the most from Chrysler's move. Ford's deal is similar to Chrysler's, except it is a six month sub rather than a 12 month sub. If Ford were to pick up the Chrysler slack, then investors will see little change in the metric. If however, a theoretical shift went to Toyota, there will be a whole other set of items to consider, as Toyota installations count towards SAC, but are not ever considered promotional subscribers. With Toyota, a radio is only a subscriber if it becomes self paying.
Needless to say, the subscriber numbers and associated metrics can be a virtual mine field of confusion, but it is wise to understand how the deals work, and what a cease in production, such that Chrysler is doing, impact the metrics.
How should investors proceed? Monitor car sales each month to see who is gaining market share and who is losing it. Consider the penetration rates of these OEM's and how they impact the metrics of Sirius XM. If you take the time to understand this, not only will you have a more solid grasp of the numbers, but you will have a leg up on all of the confusion that exists in following this equity.
Position - Long Sirius XM Radio, No Position OEM's