While subscriber gains have usually been the focus of most discussions concerning Sirius XM (NASDAQ:SIRI), the increase in average subscription fee is another important factor governing the satellite radio company’s growth. Sirius XM’s average subscription fee rose by roughly 5% in 2012, amounting to $124 per subscriber per year. This was primarily driven by the price increase that the company implemented last year, and the impact will be visible in 2013 as well due to the gradual roll-out.
Going forward, we expect Sirius XM’s average subscription fee to continue to increase at a moderate rate of close to 5%. While the adoption of Internet add-on, a compelling radio service and rising royalty costs could push the average subscription fee higher, growing competition and promotional discounts are offsetting factors.
Possible Price Increase In The Future
Although Sirius XM does not have a history of frequent price increases, we believe that its compelling service and rising royalty rates provide both an opportunity and incentive to raise prices in the future, perhaps in the form of different tiers.
Every year Sirius XM pays a large sum to its OEM (original equipment manufacturers) partners to keep its radio equipment flowing into the new car market at around a 60% penetration rate. Of these 60% who buy a car equipped with satellite radio, just under half (45-46%) tend to convert to self-pay subscribers after the promotion trial runs out. That’s a healthy rate and speaks for the demand for its radio service.
Sirius XM’s business model is based on subscription fees and therefore the company is able to afford unique and exclusive content that separates it from other radio service providers. For instance, Sirius XM’s contract with Howard Stern which was due to expire in 2010 was renewed. The previous five-year contract with Stern was worth $500 million. The company also inked an exclusive deal to provide Stern’s show on its mobile app. Stern is a popular figure and his show attracts over 12 million listeners a week.
Sirius XM has also launched its product Lynx to leverage the growing Internet usage and boost its retail subscriber base. Listeners can use this portable device to connect to the Internet and listen to on-demand music. This way the company is becoming a hybrid radio service provider by leveraging both satellite and Internet media.
Increasing Royalty Rates
Under the terms of the Copyright Royalty Board’s decision, Sirius XM paid royalties of 6.5%, 7.0%, 7.5% and 8% of gross revenues, subject to certain exclusions, for the years 2009, 2010, 2011 and 2012 respectively.  It is likely that the royalty fee will continue to increase in the near future and the company may try to pass on increased costs to subscribers in the form of higher prices. The Copyright Royalty Board has also set the royalty rates for Sirius XM Internet radio. These rates do not apply to satellite radio as it is a different medium. The rates are charged on a per-performance basis, implying that if 100 users listen to one song, it amounts to 100 performances. As the Internet radio royalty rates increase, Sirius XM is likely to pass on these increased costs to its customers, leading to growth in average subscription fee. The table below provides summary of preset royalty rates for the next few years.
|Royalty Rate Per Performance||$0.0016||$0.0017||$0.0018||$0.0020||$0.0021||$0.0022||$0.0024|
Adoption Of Internet Radio Add-On Will Help
While most of the radio listening occurs inside the vehicles that come fitted with satellite/terrestrial radio equipment, Pandora (NYSE:P) has proved that there is a big market for Internet radio as well. The company has over 65 million active users who use its Internet radio service on smartphones, tablets, computers and a variety of Internet-enabled devices.  In 2009, SiriusXM started offering Internet radio add-on service, which is currently priced at $3.50 per month. We believe that over time, more Sirius XM subscribers will sign up for this service as it will provide them flexibility and convenience and expand their listening experience to multiple devices.
To strengthen its Internet offerings, Sirius XM launched an on-demand service in 2012 that allows its Internet subscribers to choose their favorite episodes from a catalog of more than 300 shows and over 3,000 hours of listening content on smartphones and online. 
However, Competition & Promotional Pricing Can Put Negative Pressure
Sirius XM is going to face more competition in the future from players such as Pandora, Clear Channel Radio, Spotify and potentially Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT). The U.S. radio market earned a little over $17 billion in revenues in 2011, and this figure is expected to grow past $22 billion by 2015.  The in-vehicle radio market accounts for roughly half of this, which is why several big players are likely to make efforts to get a share of this market. As competition increases, Sirius XM will find it difficult to grow its subscriber base and could resort to more promotional discounts.
Pandora is increasingly pushing into the automotive segment. In January 2013, it partnered with the Chrysler group, expanding its radio service to 85 vehicle models. Similarly, Apple is expected to launch its radio service somewhere in 2013 and is likely to push for integration in cars. The advantage that Apple has is that the integration of iOS in cars will have multiple benefits including navigation, on-demand music, Apple’s radio service, connectivity to other Internet apps and synching music from Apple devices. Therefore, the company has a strong marketing point and could threaten Sirius XM’s dominance.
Promotional discounts were the primary reason behind the slight decline of 0.8% in Sirius XM’s average subscription fee in 2011. The company stated in its SEC filings that an increase in subscription discounts offered through customer acquisition and retention programs could not be offset by a higher number of subscriptions to premium packages, data services and Internet add-ons. This leads us to believe that although there are many factors that make a strong case for growth in Sirius XM’s subscription fee, the growth will be moderated by the possibility of higher promotional offers as competition increases.
We currently forecast Sirius XM’s average subscription fee to increase from $124 per subscriber per year to close to $175 by the end of our forecast period, implying an average annual growth rate of close to 5%. However, if this figure increases to $200 instead, there could be more than 10% upside to our price estimate.
Currently 80% of Sirius XM’s subscribers are paid subscribers.  If we assume that this percentage will remain constant over time, $200 of annual subscription fee will imply that the ‘paid subscribers’ will be spending close to $20 every month on Sirius XM’s service. This would mean greater adoption of the Internet radio add-on service, more people subscribing to higher tiers as well as implementation of price increases by the company. This is quite possible if Sirius XM can maintain its competitiveness against the new entrants.
We believe that any downside due to slower growth in subscription fee is unlikely. However, just to give a sense of the potential, there could be 10% downside if the average subscription fee reaches only around $150 per subscriber per year by the end of our forecast period.
Our price estimate for Sirius XM stands $2.34, implying a discount of about 20% to the market price.Notes: