How Are Sirius XM’s Profit Margins Trending?

It is reassuring that Sirius XM’s (NASDAQ:SIRI) topline growth hasn’t come at the expense of its margins, thanks to the popularity of its subscription model. This is one of the reasons why the stock has gone up significantly this year. The company’s price increases have been well-received and the content quality and variety keep customers interested. This has helped Sirius XM manage its content costs much more efficiently than other radio services operators such as Pandora (NYSE:P).

As a result, its adjusted EBITDA margins (earnings before interest, taxes, depreciation and amortization) have increased from 26.1% in 2009 to 37.4% in 2012. This figure excludes stock-based compensation. If we take a look at the individual cost components, we find that the company has gained operating leverage in several areas due to its growing subscriber base. While the revenue share and royalty costs have gone up as a percentage of revenues, administrative costs, marketing costs, programming & content costs and subscriber acquisition costs have come down. Going forward, we expect Sirius XM’s adjusted EBITDA margins to continue to increase and reach 45% by the end of our forecast period.

See our complete analysis for Sirius XM

Content Costs Are Trending Favorably

Sirius XM’s overall content costs, which include revenue sharing & royalty costs as well as programming & content costs, account for about 37% of its total operating expenses. As a percentage of revenues, these costs declined from 31% in 2009 to 28% in 2012. This may be surprising given that the royalty rates for music increased each of these years, which is primarily the reason why Sirius XM’s competitor Pandora is still making losses. However, unlike Pandora, Sirius XM can afford a wide variety of content including talk shows and sports programming due to its subscription-based business model. We believe that the company has done well in terms of saving money on these content agreements due to its strong negotiating power and the absence of a central body governing the rates. After the merger of Sirius and XM, the company started reducing duplicate programming and has renewed or replaced expiring agreements on more cost effective terms.

Costs Related To Subscriber Acquisition, Marketing And Administration Are Coming Down

Sirius XM’s subscriber acquisition costs primarily include hardware subsidies paid to radio manufacturers, distributors and automakers, device royalties for certain radios and chip sets, commissions paid to automakers and product warranty obligations. As a percentage of revenues, these costs have declined slightly over the last few years. This was expected and is typically the case with most companies. As the brand value increases and the service becomes popular among customers and original equipment manufacturers, Sirius XM will need to pay less commissions and subsidies.

Additionally, other operating costs including sales & marketing and general & administrative costs have been on a down trend as a percentage of revenues primarily due to operating leverage gain. Sirius XM has seen healthy revenue growth over the past few years due to accelerating subscriber additions and the implementation of new pricing. The subscriber growth has resulted primarily from the growth in the U.S. automotive market with some meaningful contribution coming from the company’s efforts to tap the used car market.

Growth In The U.S. Automotive Market Is Helping Sirius XM Gain Operating Leverage

U.S. car buyers purchased roughly 1.4 million cars and light trucks in June, bringing the half year new vehicle sales to about 7.8 million. ^[1] This implies growth of roughly 7.7% over the first half of 2012 which suggests that the U.S. automotive industry could see another record year as sales continue to climb since the recession of 2008-2009. Vehicle sales for Q1 2013 reached about 3.7 million, implying growth of roughly 7% over the first quarter of 2012. However, this growth accelerated slightly in the second quarter with June sales increasing by more than 9% over the same period last year. ^[1] Sirius XM stated during its Q2 2013 earnings announcement that vehicle sales in the U.S. could reach 15.5 million this year, thanks to the gradual improvement in the economy and better financing deals.

As of August 2012, Sirius XM’s satellite radios were installed in 50 million cars. However, only a fraction of these are active. The company expects that over 100 million cars will have factory-installed Sirius XM radios by 2018, and about 150 million will have it in the next 10 years.

Our price estimate for Sirius XM stands $3.20, implying a discount of about 15% to the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. U.S. Car Sales Pace Hits Five Year High, The Wall Street Journal, July 2 2013 [↩] [↩]