The time has come once again to outline my expectations for Sirius XM’s quarter. Over the past few quarters we have seen improvement on some metrics, slippage on others, and some serious one time charges. Q2 will be more of the same.
With all that has happened, it is difficult at best for expectations to be met on some metrics. For whatever reason, there are known one time charges that will impact the company but as yet have not been built into models by analysts. In fairness, analysts have not published their Q2 projections yet, and some may revise to take such charges into consideration. If that does not happen, we can expect to see headlines that the company missed estimates, and the debate about one time costs will rage in the forums.
The company has not yet disclosed a number in association with paying off debt early. The number is likely to be substantial, and could impact the EPS by as much as a nickle. Thus, what investors need to understand is the reality of such one time charges and balance that against the perception of the street and mainstream media. The facts are that the loss, even if only a one time loss, is real. Understanding that it will not happen again next quarter is also real. Thus, if the perception is a bad miss this quarter, those same investors could be in for a surprise next quarter.
Let’s get this out of the way first. Subscribers will once again come in on the negative side. The slip will not be as bad as Q1, but given what transpired in the quarter, a negative number is pretty much a foregone conclusion. On the positive side of things, the slip has less to do with consumers not wanting the product, but instead a drop in production and sales in the OEM channel. Specifically, the shut down of Chrysler production took a toll on the promotional subscriber number. The GM shutdowns will impact Q3 because of the nature of how subscribers are counted. Some expect this slowdown to be offset by the iPhone app, and Certified Pre-Owned programs, but in my opinion these numbers are negligible.
The good news is that it would appear that churn will improve. Last quarter I had used an “ALL-IN” churn number of 3.2%. The “ALL-IN” churn was actually closer to 3.1%. The basis for improved churn is in how deactivations typically happen. The company gives consumers a thirty day grace period in an attempt to market those subscribers to renew. The biggest subscription quarter is Q4 with most activations happening in the week after Christmas. Thus, subscriptions expiring in Q4 2008 would get a grace period into Q1 of 2009. With the economy being what it was, and consumers trying to figure out a way to pay their bills, the timing couldn’t be worse for renewing. This would lead to higher than normal churn. While channel shuffles and price increase announcements would have some impact, those conditions are negligible in my opinion.
I forecast gross subscriber additions in the neighborhood of 1,165,000. This would be down from the 1.33 million of last quarter. With lower churn, and a few positive marketing efforts, the total for subs count will still be negative, but will be slightly better than last quarter. With “ALL-IN” churn at 2.7%, we could potentially see the the subscriber count decrease by about 300,000 to 340,000. This would bring about a total of 18,259,000 to 18,299,000 subs for Q2.
Potential surprises could come from a better than expected retail number, and better than anticipated success of the iTunes app at bringing in new subscribers. I would consider deactivations of under 300,000 to be a surprise to the street.
Sirius XM reports “Self Pay Churn”. This metric captures the deactivations of subscribers who are self paying. Last quarter Sirius XM saw Self Pay Churn come in at 2.2%. This represented the high end of the range we gave last quarter. In my opinion, Sirius XM will see improvement here because of of the traditional holiday bump we see in Q1. In addition, the loyalty of the self payed subscriber base has been fairly consistent. Self Pay Churn should come in between 1.8% and 1.9%. The churn metric will be one metric where the company can show a marked improvement.
The revenue line will be a decent metric for the company this quarter, but nothing really special. The street is expecting revenue of about $607 million, but may have not considered some potential items that will help revenue, as well as a decrease in subscribers as large as I am projecting. The Sirius XM iPhone app will deliver a few bucks, but came late in the quarter. Existing subscribers who use the app will find themselves paying an extra $3 per month. The numbers will not be huge, but every little bit helps. Price increases will carry only a minimal impact. With a high percentage of subscribers in prepay plans, the price increase will not be material until those plans expire. The impacts of the price increase, both positive and negative, will be spread out over the next 3 or four quarters. The biggest hit comes in the loss of subscribers. Revenue between $575 million and $600 million would not be a surprise to me. While it is possible that the company could beat last quarters revenue, I feel the only way it could be accomplished is if there has been an improvement in advertising.
Average Revenue Per User (ARPU)
Average Revenue per user is a metric that will begin to see steady improvement over the course of the next year. Between price increases, the new family plan rate, and the Internet streaming fees, the company will see the ARPU improve each month as these costs get built into the mix. Most cost increases will happen over time. Those that are already on annual plans will not be impacted by increases until their renewal comes up. This quarter Sirius XM should see improvement in ARPU because of new subscribers paying higher rates, and the initial success of the iTunes app. The new revenue from iTunes in my opinion is going to be dominated by existing subscribers upgrading their subscription to take advantage of the service on their iPhone or iPod Touch. New subscribers delivered from the app are likely minimal, and will not deliver huge revenue or subscriber numbers. Investors should look for ARPU in the $10.50 to $10.55 range.
Subscriber Acquisition Cost (SAC)
Subscriber acquisition costs are the costs associated with gaining new subscribers. This cost is determined per gross addition, and includes subsidies, marketing, etc. Last quarter the SAC came in at $61. Typically the bulk of SAC costs come from the OEM channel. Due to production slowdowns, the company should be able to save quite a bit of money. The new iPhone app will generate some subs, so this will give a boost because the app is subsidy free. Look for the company to show improvement in this line item, but nothing substantial. The SAC could come in between $55 and $58 in my opinion. Sirius XM saved money in the OEM channel, but their advertising surrounding the iPhone app stepped up quite a bit from the norm.
This measures the amount of satellite radio’s installed in the overall production of cars. This metric is important because it demonstrates growth in the OEM channel. The penetration rate last quarter was 53%. The company stated that they anticipate being in the high 50’s by the end of the year. What we should realistically look for is a penetration rate in the neighborhood of 55% for Q2.
Take rate represents the number of consumers that elect to keep the service after the promotional period. Those that elect to become subscribers fall into the self pay category. Those that do not will become deactivations, and fall under the unofficial metric of “ALL-IN” churn. Last quarter the take rate was in the mid 40’s. I look for the take rate to remain flat, with a small dip possible. As the penetration rate gets bigger, it is very possible that we will see a natural decline in the take rate. Satellite radio is a pay service, and it makes sense that consumers of some car models would be more likely satellite radio candidates than other models. As the lower end models begin to see more installations take rate will naturally suffer. The key going forward will be getting to a reasonable constant that investors can hang their hat on. We are not there yet, but should be able to have a much better idea on this issue a few quarters down the road.
EARNINGS PER SHARE (EPS)
This will be the tricky metric for the quarter, and this metric will be the subject of a ton of debate. The reported earnings will be a miss. The street is expecting a $0.01 loss, but so far no analyst has considered the major charges that will impact this line. Sirius XM Radio has not yet published the impact of the recent XM Radio debt refinancing. The number will be substantial, and could impact the EPS by several pennies. Thus, the company will announce a big hit, but will qualify the statement by noting that a big portion of the hit will be attributable to one time charges. While SiriusBuzz readers will know about this because we are making note of it, most investors will be caught off guard. I foresee negative headlines being the norm by mainstream media, and that could put a good deal of pressure on the stock. Aside from the one time impacts, I see the company meeting street expectations, with a slight chance of beating them. However, investors should be prepared for an EPS loss to be much more substantial than $0.01 per share.
In my opinion the quarter will demonstrate more merger synergies and show that the company is on the right track. The refinancing in the quarter was a prudent move for the long term prospects of the company. The iPhone app will get positive discussion in the call, but don’t look for much color on the matter beyond perhaps the number of downloads. Sirius XM will have many positive aspects to report on, but the alignment of all of the metrics moving in the proper direction is not something we will see here in Q2.
The impact on investors is almost predictable. If history has taught us nothing else, we know to expect a run-up going into earnings followed by mainstream reporting on the quarter that highlights the negative. Realistically speaking, the company has not demonstrated a knockout quarter in quite some time that would silence their critics. That “perfect” quarter may come at some point, but not in Q2. Investors will see signs that free cash flow is around the corner, but the wait continues.
Position – Long Sirius XM