While subscriber and revenue growth remained strong for Sirius XM (NASDAQ:SIRI) during Q3 2013, the stock fell as the company’s earnings missed consensus estimates due to higher content and marketing expenses. Growth in the U.S. car market, a robust business model, quality content and strong dealer partnerships remain the driving force behind Sirius XM’s business. However, the recent performance should be taken with a pinch of salt given the rising royalty and marketing costs, expected increase in competition and the change in OEM contracts that will lead to a significant decline in net subscribers additions for the fourth quarter.  Sirius XM has had a good run, but the growth might slow down in the coming quarters which is one of the reasons why the company is resorting to another price increase next year.
Our price estimate for Sirius XM stands $3.44, implying a discount of little over 10% to the market price.
Industry Tailwinds Continue To Help Sirius XM
As clearly evident, a bulk of Sirius XM’s growth is driven by the strength in the U.S. automotive industry.
U.S. customers purchased roughly 1.4 million cars and light trucks in June, bringing the half year new vehicle sales to about 7.8 million, implying growth of roughly 7.7% over the first half of 2012 .  Following this, sales went up by roughly 8% in the third quarter of 2013 despite a slowdown in September. For the month of June, the figure jumped 9.2% amounting to 1.4 million units.  This growth was the highest the industry has seen in the last five years and stood notably above the figure for the first half of the year. August was even better with vehicle sales surging by 17%  However, September saw a slowdown as sales fell by 4.2% according to data available from the Wall Street Journal.
For the full year, Sirius XM is pegging total U.S. vehicle sales to reach between 15.5 million and 15.6 million, and has raised its subscriber guidance to 1.6 million net additions. 
The Outlook For 2014 Isn’t Bad
As Sirius XM heads into 2014, there are certain driving forces that will help its growth. The company is benefiting from a favorable vehicle mix and has extended its deal with Honda till 2020. The new vehicle penetration rate stood at 70% in the third quarter, the highest in Sirius XM’s history.  Although some OEM contract adjustments will impact growth in the fourth quarter, the long-term deals with automakers will allow the business to flourish. Additionally, Sirius XM has decided to raise the monthly price for its core service by $0.50 starting next year, which will further add to its revenue and margin growth. The company expects its revenues to cross $4 billion in 2014, with adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) growing by 21%. 
However, There Is Some Cause For Concern
Besides the fact that net subscriber additions will fall significantly in Q4, we are concerned about the rising royalty and marketing costs. Revenue share and royalties as % of subscription revenues have increased from 17.4% in 2009 to 18.6% in 2012, and are on their way to touch 19% this year. Although the company has more than compensated for this by gaining leverage in other expense categories, that may not continue. As the industry gets more competitive, subscriber acquisition costs and marketing costs could go up, which is something that the stock market may not be taking into account.
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 go 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.Notes: