There was a time in the history of Sirius XM when it was treated as a technology company by the market and investors. Tech companies were a hot topic, and being a tech company was sexy. The fact that people treated the company as part of the technology sector was not necessarily wrong, after all, satellite radio was a new technology, and in the early years, Sirius and XM were partially driven by the technologies they developed. However, the future of satellite radio rested not in their technology, but rather the content they could deliver and thus, a day would come when Sirius XM would finally be considered by what it is...A MEDIA COMPANY.
For decades media companies have measured their success or failure in Earnings Before Interest Taxes Depreciation and Amortization or EBITDA as it is commonly referred to. Before anything else, investors need to understand that EBITDA is a NON-GAAP metric. GAAP stands for Generally Accepted Accounting Principles, and because GAAP metrics are constants, they deliver the real meat and potatoes of how a company is performing. Where GAAP can become frustrating is in dealing with things like one time charges, or dealing with expensive assets that are written down over long periods of time. EBITDA was seen as a way to value a company against its peers based on certain criteria that take away the paper losses.
Essentially, EBITDA was created as a metric to show a companies viability and their ability to service their debt. It is not necessarily a good measure of free cash flow, items that offset revenues, and profitability. By example, In Q1 2010 Sirius XM reported EBITDA growth but negative free cash flow. This leaves many investors with questions about whether or not the company is performing well. Some will argue that EBITDA offers a clearer reflection of operations because it removes expenses that can cloud company performance. In some cases this is true, but total reliance on EBITDA can be a dangerous practice. The use of EBITDA is not right or wrong, it is simply a tool to help investors get an idea of where a company stands.
Sirius XM Radio investors often hear the terms EBITDA and Adjusted EBITDA attached to the company, but many wonder what it really means. EBITA growth is a postive, but it does not and can not exist in a vacuum. In valuing Sirius XM into the future it is a valuable tool if other outside metrics are all falling into line. This is where confusion seems to set in. If Sirius XM is demonstrating 20% EBITDA growth, should analysts use a 20x multiple in valuing the company? Why do some analysts seem bearish when EBITDA is growing? The quirks happen because of what is being excluded for EBITDA, and in the nuance of what Adjusted EBITDA is.
At the end of the day, EBITDA growth is a good thing. Cost controls, cash flows and improving revenue are also important. Both need consideration. By function, EBITDA ignores certain fixed costs such as Interest payments and taxes. Sirius XM has substantial debt, and will pay substantial interest over the coming years, this debt and interest needs to be considered by investors. Specific to Sirius XM, think of capital expenditures. This company has to spend a lot of money on satellites. EBITDA does not capture these expenses. It is possible for a company to have huge capital expenditures, yet report a positive and/or EBITDA.
EBITDA is most reflective when a company has a stable business in the categories not considered by EBITDA. Sirius XM is improving in all of these areas, but there is indeed still more that needs to improve. Over the coming months the company will likely continue to clean up their balance sheet. This will give the EBITDA metric more gusto going forward.
Currently Sirius XM trades at about 15x EBITDA while showing 20% EBITDA growth. That would give the appearance of value in the equity that an investor may consider as upside. However, when you measure against operating income you see a differing picture.
The thing investors need to consider is that Sirius XM is in the media sector, and media sector companies are valued on EBITDA, and have been for quite some time. The issue is that savvy investors will go beyond EBITDA to understand whether the rest of the metrics are demonstrating the same type of growth that the EBITDA number is representing. If metrics and valuation models across the board are in alignment, then it is pretty safe to assume that EBITDA growth is indeed giving a decent representation of company performance. If other calculations show something different, then you need to consider those findings against EBITDA.
So how should an investor value Sirius XM? Look for continued Adjusted EBITDA growth, but cross check that with an understanding of cash flow and whether the company is seeing a profit. What you want to see is top line growth that can flow through down to the bottom line. For Sirius XM that means subscriber growth, ad revenue growth, controlled SAC, and possibly price increases in 2011.
Position - Long Sirius XM Radio