Bank of America analyst Johnathan Jacoby issued a report today regarding Sirius Satellite Radio. In the report he urged people not to "be fooled" by subscriber numbers. In this piece we will show you the steps that Jacoby did not illustrate. My comments after the report excerpts:
Sirius Satellite Radio Inc. (SIRI)
Rating: Neutral, Price: $3.61, 12-Month Target: $2.75, Market Cap.: $5,483.6 MM
Jonathan A. Jacoby
Don’t Be Fooled by Sub Metrics:
Underlying Fundamentals Worse Than Expected - Reaction: Negative - SAC and Cash EBITDA were WORSE than expected, despite higher net adds and lower churn.
3Q07 net adds of 525k beat our estimates of 410K and 425K consensus, driven by the strength in the OEM channel. Don’t be Fooled: OEM net adds came in at ~463K (vs. est. 322k), driving higher SAC of $103 (vs. est. $95) and lower churn of 2.1%, however, we believe this is simply a timing issue. The high ramp of OEM over the last two quarters will catch up on the churn rate over time – as the higher OEM net adds for the quarter are understating churn as those subs are subject to ~ 6 contract month period where, by default, no churn can occur. Retail subs continue to disappoint, retail net adds were below our estimate at 64K versus our 88K estimate.
Key 3Q Metrics:
o Gross adds of 999k topped our estimate of 909k
o Net adds of 525k were greater than our estimate of 410K
o Subscriber churn of 2.1% vs. our 2.3% estimate
o Average subscription ARPU of $10.32 was worse than our estimate of $10.60
o SAC of $103 was higher our $95 estimate
o Cash EBITDA loss of $57M was ~$20M than our estimate of $37.1M
Investment thoughts – Focus is on the deal, street is more optimistic than our contacts, and the underlying long-term fundamentals appear to be weakening: The Street remains solely focused on the merger while ignoring the fundamentals. On the deal front, our contacts remain more skeptical than the Street noting the high hurdle to demonstrate that this merger is not 2 going to 1 (and we concur). And the fundamentals continue to weaken (don’t get fooled by the sub beat) – higher SAC than expected results in lower cash EBITDA. We would not be surprised if “car lot” subs increased to over 10% of total
subs – but even if they remained at 10% that would imply that ~770K subscribers are not real subscribers. That is more than the net adds during the quarter. In summary, expenses are higher, churn rate is being artificially held down due to OEM push, and advertising was weaker. Lastly, valuation is far from attractive - deal or no deal – XM/SIRI proforma deal is trading at ~16x ’10 proforma EBITDA with $150M of synergies.
Jacoby is quick to point out that he feels that the Sirius metrics are simply a "timing issue", and that the ramp up of installations will "catch up" on the churn rate over time. This is an interesting theory. Sirius has been "ramping up" the OEM channel for quite some time now. We saw the impact of that as fully loaded churn went from 1.8% to 2.3% last year. This was expected. No one was trying to fool anyone. Sirius has in fact guided to a churn rate of between 2.2% and 2.4%. Those that follow the sector closely are fully aware of this impact.
Jacoby states that the churn is therefore artificially low. Why has he not made a similar argument for ARPU? After all, the period at which a car is on a dealer lot is not generating any revenue yet. Does this mean that ARPU is "artificially low"? OF COURSE NOT. The metrics are what they are based on the structure of these deals. Sirius large OEM contracts are churn friendly and cash flow friendly, but there is a negative impact on ARPU. If you are going to make one assertion regarding the churn side of the house, you then must also look at the entire picture. Looking at one component and ignoring the other is a fools errand, and that is exactly what Jacoby did. Nowhere in his report did he address this. He stated that ARPU was worse than he expected. If he was able to crunch the numbers to justify his miss on churn, why not crunch the numbers to see why his ARPU was off by so much? If he did do that, he would have found that the ARPU would have beat his estimates.
Looking at his expectations, one has to ask why there were so many misses in his analysis all around.
Jacoby said expenses were higher. Of course they were. Sirius brought in 90,000 more subscribers than he anticipated.
Jacoby said churn was "artificially low". Why not say the same about ARPU?
Jacoby said retail is weaker. Everyone already knew this. It has been a major topic throughout the year. Knowing that XM was going to be negative at retail, what exactly was Jacoby expecting Sirius' Gross retail share to be? over 70%?
Jacoby said advertising was weaker. As yet, advertising is not a driving force in satellite radio. How much improvement over last quarter did he expect?
Who is fooling who here?
Tyler Savery Position - Long Sirius, Long XM