Despite the fact that Sirius XM Holdings Inc. (SIRI) has been growing pretty impressively, at least in terms of revenue and EBITDA, in recent years, the response of SIRI stock has been neither here nor there.
Case in point, after SIRI announced record revenue and subscriber data for 2015 earlier this year, SIRI stock responded by losing about 7.5% of its value a week after the results were released.
This could mean that some more business- or industry-related fundamental issues are making investors see SIRI stock differently than its financial figures would have us believe.
SIRI stock is expected to report its 2016 first-quarter earnings before the market opens tomorrow. And everything is seemingly working in favor of SIRI stock at the moment, with many analysts updating their earnings estimate in favor of SIRI, Zacks reports. This is indicative of a potential earnings beat.
On the average, analysts expect earnings to coming at 3 cents per share. That would be a one-cent increase over 2015 first-quarter EPS. Analysts expect revenue to come in at $1.18 billion, which would be a 9.2% increase from the prior-year quarter revenue.
But as we’ve seen with SIRI stock, such an earnings beat may not initiate a rally. So there is ONE thing to watch when SIRI stock reports its earnings. This item could partly affect the way investors respond to its earnings, as it actually gives indications to what the future could look like for SIRI.
Sirius XM’s Conversion Rate
For starters, SIRI defines conversion rate as the percentage of new car buyers that become paying subscribers when their free trials end. Management said during the Q4 and FY 2015 earnings call that the conversion rate dropped below the 40% mark for the first time in its history.
SIRI said this was because, as automakers are expanding, Sirius XM radios were gaining entrance into more economical cars, whose owners are less likely to pay for a premium radio service.
This explanation seems right, and it should make investors feel at ease.
But, in the real scheme of things, it makes things more expensive for SIRI stock. I mean, installing its satellite radio in economical cars comes at a cost. So if the owners of these cars won’t subscribe to a premium radio service, both the equipment and the money used for installing the equipment are wasted.
This is indicative that SIRI stock might find it difficult growing its profitability in few years because, let’s face it, most of the connected cars that would be out there over the long haul would be economical cars. So will SIRI continue to install satellite radios free that no one ends up paying for?
This will invariably make SIRI stock less profitable.
The Subscriber Acquisition Cost Proof
And if you need proof, I’ll point you to the subscriber acquisition cost as a percentage of subscriber revenue.
For the previous four years before 2015, SIRI stock was able to reduce its subscriber acquisition cost as a percentage of subscriber revenue by close to a percentage point on a year-over-year basis, with the lowest being a 0.7 percentage point decrease.
This indicates that SIRI stock has been garnering more subscriber revenue from lesser cost.
However, in 2015, this metric remain roughly the same with 2014. And I believe that’s where the effect of the dip in conversion rate shows up.
So if SIRI is going to continue down the path of installing its equipment in new, economical cars, we should expect that this metric would start increasing, hence making SIRI less profitable. So investors really want to keep track of its conversion rate when SIRI reports tomorrow.
And with the future dynamics of Sirius XM’s business model looking less profitable, I believe investors should look elsewhere for growth.
As of this writing, Craig Adeyanju did not hold a position in any of the aforementioned securities.
