One thing investors always need to understand is that a typical public company paints the picture they want you to see. There is nothing at all wrong with this, as human nature dictates that we seek out the good things and tend to avoid the bad. Further, we will often make what is marginally good seem better than it actually is in an effort to tell ourselves that we made the right decision. essentially we tend to want to justify our choices.
With Sirius XM there is sometimes a tendency to project upon the company expectations that simply are not reasonable. Investors also tend to try to find the focal point to watch instead of digging deeper and making the determination of exactly what it is that makes a company money.
For Sirius XM that is SUBSCRIBERS. It is SUBSCRIBERS that generate the cash that will lead to improved EARNINGS. If there are fewer subscribers, or those subscribers are paying less on average, the EARNINGS, REVENUE, and FREE CASH FLOW will all suffer. It is for this reason that tracking what is happening with subscribers is still important even though Sirius XM management would tend to focus people on cash flow and EBITDA.
That focus is great as long as your expectations on subscribers are met. It is actually impossible to build a realistic analytical model for Sirius XM unless you start with the BREAD AND BUTTER of the company...SUBSCRIBERS. Ever since the day that I "dared" to point out that there is perhaps an issue with 2011 subscriber guidance I have been under attack. As I laid out the facts, people seemed to rethink their stance on the issue and came up with statements such as, "they may miss by a little bit, but that is not a big deal...2012 will be huge". The problem is that HUGE YEARS have been projected and then put off until next year for years now.
I have even seen some project that Sirius XM will meet their guidance while at the same time projecting that gross additions for Q4 2011 will be at 2,250,000. Apparently digging deep is just not in the DNA of some people. Consider this:
- Deactivations last quarter were at 1,804,000.
- The company needs 442,000 to meet guidance.
- If the company keeps churn rate (on a percentage basis) exactly the same the deactivations number will be higher than 1,804,000 this quarter. This happens because the number of self-pay subscribers is higher (i.e. if a company had 1,000,000 subs last quarter with a churn rate of 5%, then 50,000 would deactivate - That same 5% applied to 1,100,000 subscribers would mean deactivations would be at 55,000. The churn rate stayed the same, but the absolute number rose).
- If the projection is 2,250,000 gross additions, and the company is going to meet guidance, that would imply that deactivations will need to be 1,808,000 (only 4,000 more than last quarter). Meanwhile since mid 2010 deactivations has gone up every quarter, from 1.4 million in Q2 of 2010 to 1.8 million in the most recent Q3. That is a jump of 400,000 deactivations or an average jump of 67,000 per quarter. Is it realistic to think that Sirius XM will announce a decline in deactivations in Q4 2011? Not without raising eyebrows. Essentially, anyone who projects that the company will meet guidance, AND projects that gross additions will be 2,250,000 is saying that the company will somehow find a way to improve churn to a point that absorbs 67,000 (bringing it down substantially), and/or implement retention programs that bring down the value of a subscriber. These are things investors will want to know sooner rather than later. The short term investor needs to know because a potential guidance miss adds risk. A long term investor needs to know this because if you are tracking your investment you are making an assumption of a certain level of growth when it may actually be lower.
The biggest point here is not whether or not they hit the number, but the way in which they hit it. If it happens through natural growth then that is quite acceptable. If they hit the number by devaluing subscribers, then that could bring a problem. As we look to 2012 investors are excited about a year that includes a price increase, limited capex expenditure, and limited debt issues. This could stack up for some wonderful news on the EBITDA and Free Cash flow metrics. As long as the subscriber picture shows reasonable and valuable growth, it will indeed be a stellar year for the company. If the subscriber picture (THE BREAD AND BUTTER OF THE COMPANY) is slow to grow, then that presents a long term issue that should be considered.
With a price increase the company has a lot of new and built in wiggle room. Trying to determine what that wiggle room is the trick. What if ARPU would normally rise $0.15 cents in a quarter, but because of retention efforts and discounting it rises $0.10? The reason this potential wiggle room exists is because it will take about 2 years for the company to fully realize the price increase due to prepayments of consumers locking in at the lower rate for a long period of time. As long as the company guidance takes that into account, and investors temper their expectations, there is no issue. Keeping subscribers, even at a lower rate, is part of the business.
In summary, the subscriber number is the most important metric of this company. It is the very foundation of how Sirius XM makes money. It is an essential ingredient of Earnings, Free Cash Flow, and EBITDA. Having the ability to accurately model subscribers gives you the heads up as each month passes. Waiting for Mel Karmazin to announce EBITDA, Free Cash Flow, etc. each quarter gets you the information later than you need it. In order to analyze this company one MUST be competent at looking at the subscriber picture, or know where to find that information.
One thing that I learned long ago was to try to drill down to the root of an issue. Only by understanding the basic components will you be able to have success in making informed decisions. The way you do this is to collect, study, and analyze the numbers, not by pulling a number out of thin air. Yes, it takes time, but in the end you will be much better informed than if you say gross additions will be 2,250,000, the company will hit guidance, and ignore what it takes to do that.
Long ago, in another article, I said time and time again that Sirius XM needs gross additions of over 2,300,000 if they want to hit guidance. I also stated that reasonable deactivations would be at 1,875,000 (with 1,850,000 being a reasonable low end). My opinion is that the mix of auto sales (the raw sales and production figures) were not as helpful as they could have been. Production is less than Q2, trailing suppliers were less, and point-of-sale suppliers is substantially less. In addition, the failure of the company to get out the Lynx put a damper on retail. The company can indeed meet guidance, but we as investors better hope it is because gross additions are up over 2.3 million rather than deactivations going down to 1.8 million.
The simple lesson here is that only a fool would ignore the subscriber picture in a business that has subscribers as their bread and butter.