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ISI Starts Sirius XM (SIRI) at Buy; Sees Potential in Growing Auto Market, Contract Talks

July 20, 2012 2:29 PM EDT Send to a Friend
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Price: $3.60 --0%

Rating Summary:
    13 Buy, 5 Hold, 1 Sell

Rating Trend: Up Up

Today's Overall Ratings:
    Up: 3 | Down: 4 | New: 7
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Investors in Sirius XM Radio (Nasdaq: SIRI) are tuning out Friday following a late-day initiation by ISI Thursday. The firm is starting Sirius with a Buy rating and $2.80 price target, suggesting 33 percent of upside from yesterday's close.

Key points the firm makes in initiating coverage:
  • Sirius has about 23 million subscribers and is the only satellite radio provider with over 135 channels.

  • Sirius has OEM deals with all major automobile manufacturers. Radios are installed in over 60 percent of all new vehicles, with a 45 percent activation rate following the promotional period.
ISI likes Sirius as a derivative play in the U.S. seasonally adjusted annual rate (SAAR) in automobile production, a segment which is showing improving numbers. Expected SAAR in 2012 is at 14 million units currently and ISI is projecting that number could reach 16 million by 2017. This could translate into 30 million total subs for Sirius by 2017, which is 5 percent CAGR from 2011.

In terms of used vehicle sales, Sirius has also begun a program which would allow those purchasing a used vehicle to receive a trial of Sirius, leading to a potential subscriber thereafter. ISI sees this market as about 24 million vehicles strong, moving to 43 million in 2015. Notably, connection and re-connection costs to acquire these subs is virtually nothing, meaning better margin potential for Sirius as well.

  • Since implementation, the 12 percent increase in monthly fees hasn't had an impact on Sirius' churn rate. ARPU is expected to increase by 50 cents per year in 2012 and 2013, with the new $14.49 per month price umbrella being processed through the sub based over the next 18 months. ISI is modeling 2.7 percent CAGR for ARPU from 2011 through 2017.

  • Speaking of margins, ISI sees key content contract resets with providers like MLB and Fox News, as well as OEM agreements with automakers, scale economics, and contributions from the used auto market could drive margins from 22 percent in 2011 up to 40 percent or more in 2017.

  • On buybacks, ISI thinks $5 billion might be in the works. Though management is aiming for 3-times gross debt-to-EBITDA, free cash flow expected to double from $700 million in 2011 to $1.4 billion by 2017 suggests a multiple closer to 4 or 5 times debt leverage. ISI also ran a restricted payments test (RPT) on Sirius senior debt, seeing the RPT basket at $1 billion in 2012 and moving to $2.9 billion 2014. The firm also commented, "Even if $2.9B is used to shrink the equity base, net debt leverage remains below 2x. However, the RPT could go away at the end of 2014 as SIRI can call the 7.625% senior notes in November 2014; and the 8.75% senior notes can be called anytime but we assume it occurs at the end of 2014." All in all, ISI thinks $5 billion in buybacks is feasible.

  • Sirius has a royalty payment dispute with SoundExchange. Currently, Sirius pays out 8 percent of gross revs in licensing fees, but would like that to decrease 1 point starting in 2013. SoundExchange thinks fees should start at 12 percent, quite a difference. SoundExchange also sees the fees increasing 2 percent each year until they hit 20 percent in 2017. ISI is currently modeling a 50 basis point increase when the decision is finalized in December. The firm also expects SoundExchange to get 10.7 percent of gross revs in 2017.

  • Liberty Media's (Nasdaq: LMCA) intentions remain an overhang. ISI thinks Liberty would like to avoid or delay paying taxes via a tax efficient monetization strategy. That strategy might look something like this, according to ISI:
    1. a transaction would require LMCA to aggregate assets that represent over 50% of SIRI’s equity value;

    2. to split those assets off into a new entity which would also require a 5-year trade or business to ensure the split is tax-free to shareholders.

    3. to merge the split-off entity via a stock exchange with SIRI under the Reverse Morris Trust (RMT) statutes allowing for the consolidation of the SIRI ownership into one security.
  • Finally, ISI simply thinks shares are cheap. The firm's model supports SIrius trading at 10.5 times enterprise value-to-EBITDA, yielding 7.2 percent on levered fully-taxed free cash flow and 12.0 on unlevered FCF. Further, ISI also supports EPS growth of 20 percent, FCF growth per share at 39 percent, and EBITDA growth of 16 percent.Shares of Sirius are down about 0.5 percent in late trading Friday.




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