Sirius XM will be announcing their Q2 earnings on August 4, 2010. The call has been highly anticipated by investors ever since the company pre-announced the addition of 583,000 subscribers, a fantastic churn rate of 1.8%, and an OEM conversion rate that is edging toward 50%. The anticipation is further heightened by what are supposed to be great auto sales figures for July of 2010. In many ways, this call is setting up to be a good one, but as usual, it is about the metrics all showing strong positives.
Sirius XM more likely than not put together a good quarter that will show improvements in many areas. There will be some comps that may be down, but there is good reason behind this. An example would be that while adding nearly 600,000 subscribers is a good thing in the long term, there are costs that need to be accounted for in the short term. These costs could drag down a few metrics, but as long as the company does a good job of explaining the reasoning behind them, all should be perceived okay. Sirius XM simply needs to paint a good picture, and have that picture accepted by analysts and the press.
Before going any further, it is important that investors understand the differentiation between GAAP numbers and the Pro Forma numbers reported by Sirius XM. Because of the rules of purchase accounting, and the valuation differences between when the merger was announced and when it happened, there are some substantial differences between the GAAP numbers and the Pro Forma numbers.Last Quarter, on a GAAP basis Sirius XM reported a NET Income of about $41.6 million. This allowed them to report an EPS profit of $0.01 per share. By contrast, on a Pro Forma basis, Sirius XM made a little over $4 million. The result would have been a break even quarter if the Pro Forma numbers were used.
Sirius XM's Pro Forma numbers are probably the more accurate in terms of company performance. In fact, Sirius XM speaks about Pro forma in virtually all metrics such as SAC, ARPU, etc. The only GAAP numbers the company speaks of in general is in relation to EPS. For this reason, I will speak about Pro Forma estimates in all categories in this article except for the revenue and operating expenses.
The company added 583,000 subscribers in Q2. This was great news, but there are still several unknowns in the midst of many. Most were scratching their heads trying to figure this out when in the end it was the huge impact of lower churn that is likely the main driver. Yes, more cars being sold was a definite factor, but even with the OEM channel averaging 1 million in sales per month, not many anticipated such a huge addition of subscribers. The pre-announcement by Sirius XM caught most off guard, and many analysts had to scramble to adjust their models to account not only for the influx of revenue these subscribers bring in, but the shorter term costs associated with growth.
Look for the bulk of the new additions to be from the OEM channel. The retail channel still exists, but there is a clear focus on getting subscribers through vehicle dashboards. Apps on smart phones will be a small contributor, as will CPO programs, but the numbers are not yet large enough to be material.
This is another metric that the company pre-announced. Self Pay Churn came in at a fantastic 1.8%. This was a marked improvement from the 2.0% the company reported in Q1. The biggest question here is how the company accomplished this. Is satellite radio becoming more "sticky" with subscribers, or is the company having to cut rates and offer promotions to keep people on board. The real answer is that it is probably a little of both. We can see that satellite is getting more sticky based on the continued improvement in the take rate. We also know that the company offers up some great incentives to get subscribers to stay. Either way, a sub contributing revenue is better than an idle radio delivering no money at all.
I look for the company to guide to better churn if the stickiness is at a level that gives them comfort. In my opinion, 1.6% would be the ultimate goal, but I think they can guide to a 2010 churn rate of 1.7% to 1.75%. If the company is able to guide to churn down at these levels, it is something that will cause analysts to sharpen their pencils again. In the end, a current subscriber convinced to stay on board costs much less than trying to garner a new one. If you want to help EBITDA, keeping your existing subscribers is a large priority.
On the flip side, if the churn is lower because of incentives, the company may be hesitant to guide to better churn. Keeping a subscriber on board, even at a lower price, is good, but if a lot of that is happening, it will impact other metrics such as Average Revenue Per User (ARPU). The goal for the company is to present good metrics in all categories. In other words, ARPU can only suffer so much before it appears that growth in revenue is flatter than anticipated.
This will perhaps be the most interesting metric to watch. While the street seems to center on the EPS, it is metrics such as ARPU that tell the deeper story. ARPU tells us how much revenue each subscriber brings to the table each month. As long as that number at current levels or shows improvement, the company is in decent shape. With things like national ad spending increasing during the quarter, the company can possibly show a growing ARPU.
There are some potential drags on ARPU that savvy investors will want to be aware of. These tie to the OEM channel, and more specifically the category of OEM subscribers I call "leading" Leading subscriptions are vehicles that are counted as subscribers when the vehicle is manufactured because the OEM pre-pays the subscription. Companies like Ford and Chrysler supply "leading" subscribers to Sirius XM. The subscription money paid by Ford Chrysler, etc. is categorized as deferred revenue (a liability). The money will not become revenue until a consumer buys the car and begins their promotional subscription. During the time between payment for the subscription by the OEM and the sale of the car, these subscribers are contributing $0. This is a possible drain on ARPU. The silver lining is that this situation helps churn, and is cash flow friendly for Sirius XM. In addition, the OEMs are keeping a trimmer inventory than they used to, so the impact is lesser now than it would have been only a year ago.
Analysts are expecting ARPU to come in at $11.65. This would be an improvement over the $11.48 reported last quarter. The hardest thing for everyone to digest here is exactly where things stand with the royalty fees. It was, for the first time, included in ARPU in Q1. The difficulty is knowing the percentage of subscribers that are paying the fee at this point. The company has not given that data, and thus the street has to make assumptions. Personally I expect ARPU to be flat or slightly elevated. A range between $11.48 and $11.60 is where I think the number will land.
SUBSCRIBER ACQUISITION COSTS (SAC)
This is the metric that outlines the costs associated with gaining new subscribers. The company added just over 2 million gross additions. These additions cost money. Last quarter SAC per gross addition on a pro forma basis was $59. The pro-forma SAC line item was $107 million (On a GAAP basis it was $89 million). Sirius XM added 300,000 more gross subscribers this quarter over last. Using simple math and a SAC per gross addition number of $60, there is $18 million more in expense this quarter than last.
The SAC per gross addition line will likely remain stable. Expect a number anywhere from $57 to $63. As long as this number remains stable or improves slightly, this metric will not present any surprises. One analyst sees SAC at $74, but that is simply too far outside the range I would anticipate.
Street consensus on revenue is about $690 million. Analysts are in a pretty tight range with numbers anywhere from $675 million to $710 million. This is another one that may be a bit tricky due to the royalty money. Last quarter Sirius XM did $663 million in revenue. That number should elevate by some margin as subscriber numbers have risen along with advertisers coming back to the plate. Sirius XM could well report revenue between $685 and $695 million. This number will be slightly ahead of most analyst estimates, but will fall short of one or two in my opinion. That being said, the revenue line should come in pretty much in line with expectations with a slight bias to the upside.
Subscriber revenue, including effects of rebates - $600 to $605 million
Advertising revenue, net of agency fees - $16 to $17 million
Equipment revenue - $14 to $15 million
Other revenue - $56 to $59 million.
Total revenue - $686 million to $696 million
OPERATING EXPENSES (GAAP)
This is another area where Sirius XM can improve their EBITDA numbers. Cutting costs is a component of growth in EBITDA. The question is whether or not Sirius XM will be able to cut enough costs to make a dent at this point in time. We can already expect Subscriber acquisition costs to go up as a line item. The addition of 300,000 more gross subscribers this quarter over last will mean means costs for that category are going up. If we use a SAC number of $60, we will see SAC increase by $18 million.
Revenue share and royalties - $100 million to $101 million
Programming and content - $74 to $76 million
Customer service and billing - $52 to $55 million
Satellite and transmission - $19 to $20 million
Cost of equipment - $8 million
Subscriber acquisition costs - $108 to $110 million
Sales and marketing - $43 to $46 million
Engineering, design and developmentt - $10 to $11 million
General and administrativee - $53 to $55 million
Depreciation and amortization - $68 to $70 million
Share-based payment expense - $15 to $18 million
Total Operating expenses - $550 to $570 million
Interest expense, net of amounts capitalized - $78 million
Loss on extinguishment of debt and credit facilities, net - $32 million
Interest and investment loss - $2 million
Other income - $2 million
Total other expense - $114 million
Income (loss) before income taxes - $2 to $32 million income
This would represent a break even quarter with a slight possibility of a $0.01 profit if they can squeeze out another 8 million or so. Street consensus is a loss of a penny to break even. I anticipate that the company will report adjusted EBITDA of about $130 to $135 million.
This metric was already reported by Sirius XM at 46.7%. This number represents the percentage of promotional subscribers that elect to become self paying subscribers. The increase Sirius XM is very positive news, as even small incremental increases mean more dollars flowing into the company, improved churn, and improved ARPU. Sirius XM will likely highlight this metric and the progress they have made. The ultimate goal here would be to get the number above 50%, but don't look for the company to guide to that. If Sirius XM can improve this by half a point each quarter, they will be doing well. A point each quarter would be fantastic.
This metric is oft overlooked by most, and should not be. The OEM channel is the largest contributor to the subscriber number, and improvement in this line demonstrates a "stickiness" to the product.
This is the percentage of vehicles manufactured that include satellite radio. The company has been hovering around 60%. I look for this number to be higher than most expect. The company could well report penetration of 62% to 64% in the quarter. The company is focused on smart growth in penetration. When they are finding the take rate moving up, it gives them latitude to work on increasing the penetration rate. The mix here is greatly impacted by the mix of OEM's and their production as well as sales. Toyota and Nissan have been losing share to Hyundai, Ford, and GM. The latter group has a higher penetration rate.
All in all Sirius XM should be able to report good metrics across the board. If they were to perform even better than I expect, they could eek out a $0.01 EPS for the quarter. If they accomplish this it would be seen as a major coup considering that there are analysts projecting a loss of one cent. Reporting an EPS profit would carry a great perception for the equity. It would demonstrate that they have an ability to keep their earnings running while obviously investing into getting a lot more gross subscribers on board.
If the company reports a break even quarter they will likely explain it in terms of adding a large number of subscribers that will help the self-paying line item and develop into even more future revenue. Combine good news from the OEM channel with a decent quarter from Sirius XM, and we may be on the verge of becoming a less speculative equity. There is a ways to go yet for Sirius XM. They need to report a few good quarters in a row to command more respect. They do seem to be on the right path though.
If I was putting odds on the quarter I would say there is a 70% chance that the company reports a break even quarter and a 30% chance they report a profit of a penny. I simply think that Mel will have worked the cost cutting as much as possible to offset some costs, including a one time cost of $32 million that transpired during the quarter.
Spencer Will Be going over this information in greater detain on Satellite Radio News Tuesday Night at 9:00 PM EST
Position - Long Sirius XM Radio