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Sirius XM Radio Deserves a Place in Your Portfolio Now
Is Sirius XM Radio (SIRI) dead in the water?
Hardly. But I admit, this is not the scenario I envisioned for Sirius XM Radio
when I laid out a fairly simple
path to a long-term $20 valuation.Unfortunately, government delays with respect to the Sirius/XM merger, combined with financial Armageddon, got in the way.
It’s true SIRI’s stock collapsed to dangerously close to worthless, but the demise of SIRI had nothing to do with its long-term
business prospects.Satellite radio is not dead, and neither is SIRI. The only question is who will own SIRI when all is said
and done.Here’s what happened, why it happened and why I emphatically believe SIRI is worth buying now.
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The Credit Crisis, Economy & Government Intervention: A Perfect Storm for Sirius
The timing of the credit crisis could not have been worse for Sirius. The company entered 2009 with more than $3 billion in
debt, with one third of that amount coming due in 2009. What crippled the stock was Sirius’ complete inability to refinance its
debt.Fortunately for shareholders, SIRI was indeed able to replace a portion of its debt with new loans from Liberty Media. The bad
news is that such money comes at a very expensive price.Last week, S&P moved SIRI’s rating a notch higher, providing investors with another ray of hope. If indeed the company can
survive this crisis, the future looks promising. Given the changes taking place, I have a new valuation on SIRI.Here are my five reasons for owning Sirius…
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Reason #1: SIRI’s debt crisis has passed
It is incredibly expensive to launch a satellite radio business. In order to fund the cost of satellites and the acquisition
of radio spectrum, Sirius borrowed billions of dollars. After a period of several years, the company planned to pay down that
debt with cash flow or refinance the debt if more time was needed.But not in this environment. The due date on SIRI’s debt directly coincided with the greatest financial collapse since the Great
Depression. It is no wonder that bankruptcy was considered given SIRI’s inability to refund debt.But here’s the key: Sirius was in its best operating position and is now able to operate as a monopoly. Once Liberty Media stepped
up to the plate as a lender, Sirius gained time for the credit markets to heal.Though we are not out of the woods, speculative
lending will eventually return. When it does, SIRI is a credit worth betting on, given its monopolistic power and attractive cash
flow potential. To the extent the debt pressure lessens, equity will increase in value.
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Reason #2: Economic recovery will help Sirius
A contributing factor to Sirius’ demise was certainly the weakening economy in late 2007 and subsequent recession of 2008.
No
matter how great the service, subscribing to satellite radio is a discretionary item. With consumers pulling back, it is no surprise
that subscription growth slowed substantially during the year. Even worse, much of SIRI’s sales come from the auto sector. As
auto sales dropped, so did the market for finding new subscribers.With the recession expected to end this year, look for growth in subscriptions at SIRI to recover in 2010. Will it be the 100%
growth of past? No, but there is still a very large market for SIRI to penetrate, and I expect growth of 30% to 50% in the few
years after the recession ends.NEXT: Reason #3: SIRI has the advantage of monopolistic
pricing
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Reason #3: SIRI has the advantage of monopolistic pricing
SIRI was forced to endure 18 months of uncertainty while the government evaluated whether or not to approve the merger with
XM. The most important issue related to the long-term pricing power of a one satellite-provider operating environment.Even though there is plenty of competition from other media, like the Internet, iPods and cell phones, SIRI is the only game
in town in the satellite radio space. That position is incredibly powerful and valuable, especially during periods of economic
strength.Obviously, we are in a period of economic weakness. When that changes, look for Sirius to exploit its monopolistic pricing power
over time. Since Sirius hasn’t yet increased prices, the ability to do so down the road has yet to be priced into the stock. In
fact, if not for the debt and economic crisis, monopolistic pricing would be reason alone to own this stock.NEXT: Reason #4: The Government owes it to Sirius and
its shareholders
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Reason #4: The Government owes it to Sirius and its shareholders
The government has made it clear that if necessary, it will step in to save companies that are on the brink of collapse. In
the case of SIRI, it could be argued that the government was at the heart of its near failure.How in the world did it take 18 months to approve the merger with XM? The only explanation is the lobbying influence of the
terrestrial radio industry. Claims that the government was only looking out for the consumer with respect to a complicated issue
is a complete sham in hindsight. Now, with the credit crisis as the backdrop, we know what a complicated issue really looks like.Even if you contend that the merger between the two companies is indeed monopolistic, such monopoly power is necessary to allow
the company to recoup its immense cost of entering a business, given the utility to society as a whole. Greater dissemination
of information serves us all, and this merger should have been a no-brainer with respect to immediate approval.There was a great cost to shareholders of the delay, and now look for the government payback in the form of loan guarantees
or other protections should another brush with bankruptcy occur.
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Reason #5: Sirius has a superior product
I’ve heard all of the arguments against SIRI including the threat from Apple (AAPL)
and its iPod product. I’m not sold on the threat. Satellite radio offers a plethora of choices and listening options with ease
of use. The number of early adopters likely to be willing to use a competitive product is relatively small in my opinion, and
does not diminish the growth potential of SIRI.With installation of satellite now a standard in most autos, a simple activation call is all that is required. It does not get
much easier than that. As for those still clinging to terrestrial radio, there is simply no competition. Even if the so-called “King
of Media,” Howard Stern, leaves the satellite world, there is still plenty of satellite-only content, including major professional
sports content that cannot be found on traditional radio.Nothing has changed here, and if anything, the value of SIRI’s superior content has been enhanced during this period.
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My Target Valuation for SIRI
My $20 target on the stock was based on reasonable growth and revenue projections that assumed refinancing of debt in normal
market conditions.Given the crisis and near-death experience, SIRI’s shareholders have paid a substantial price for survival. That price comes
in the form of 40% dilution to Liberty in return loans needed to repay debt. At today’s price of approximately 50 cents per share,
SIRI’s market capitalization is just under $2 billion.Looking forward, I assume subscriptions increase by 30% per year, reaching 40 million by the end of 2011. At $11 per sub, annual
revenue reaches $5.5 billion. If you assume $500 million in advertising revenue and a profit margin of 30%, SIRI is making close
to $2 billion in profits.With full dilution of shares, SIRI would be earning 28 cents per share in 2012. Put a 15 multiple on that number, and you get
a valuation of $4.24 per share. Previously, I was assuming much higher growth rates and more dollars generated from advertising.
Both assumptions are still in play, assuming a stronger economy. A more aggressive valuation then would be $10 per share.The biggest change in valuation is due to the 40% dilution from the Liberty rescue. Without that rescue, though, there would
be no value for shareholders. The dreams may have faded with SIRI, but there is still a compelling reason to own the stock at
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