Is Liberty Media Paying The Right Price For Sirius XM?

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Sirius XM

Liberty Media recently proposed a stock transaction to acquire the remaining 48% stake in Sirius XM (NASDAQ:SIRI), which will result in the latter company’s public shareholders owning 39% of its outstanding common stock. [1] The move will allow Liberty Media to have a better balance sheet and capital structure, thus paving way for other acquisitions that it intends to do. The deal is valued at over $10 billion and the proposed share exchange ratio implies a small premium over the current market price. In other words, Liberty Media is valuing Sirius XM somewhere near its current market price which echoes with our stance. Our price estimate for Sirius XM stands at $3.45, implying a discount of less than 5% to the market price. We believe that the business fundamentals justify the current market valuation. Let’s see below why.

See our complete analysis for Sirius XM

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Although The Growth Is Good, There Are Risks Too

Sirius XM is certainly benefiting from the growth in the U.S. automotive market. Total vehicle sales in the country are expected to reach past 15.5 million, and this has prompted the company to raise its guidance for net subscriber additions for the full year. Sirius XM’s new car penetration rate stands at around 67%, while the new vehicle conversion rate has remained in the range of 44%-46% for the past few years. [2] The company expects more OEMs (original equipment manufacturers) to join the list of auto companies that install its equipment in their vehicles. In particular, there is an opportunity to sign up more Asian auto makers. Currently, Sirius XM’s radio equipment is installed in close to 60 million vehicles, which accounts for about 25% of total registered vehicles in the U.S. [3] The company expects this figure to grow past 100 million in the next five years and 150 million in the next decade. [4]

While there are a lot of things going well for the company, the risks cannot be ignored, which may be one of the reasons why the stock may have pulled back recently after a strong run. The cost control has been impressive, but rising competition and the possibility of a substantial jump in royalty rates remain key risks.

Under the terms of the Copyright Royalty Board’s decision, Sirius XM paid royalties of 6.5%, 7.0%, 7.5% and 8.0% of gross revenues, subject to certain exclusions, for 2009, 2010, 2011 and 2012,  respectively. It is likely that 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 customers, leading to growth in average subscription fee.

Sirius XM will face more competition in the future from players such as Pandora, Clear Channel Radio, Spotify, and potentially Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) as well. The U.S. radio market stands at around $15 billion. 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, contrary to its need to raise fees.

A Valuation Of $4 Per Share Will Imply Significantly Higher Growth

To better understand why the current valuation makes sense, we create a scenario around one of the key business drivers that will justify a meaningfully higher price. All else being equal, Sirius XM will need to add 2.7 million net subscribers annually for the next 6 years in order to justify a market price of $4. This already assumes that average revenue per subscriber will continue to increase steadily due to a periodic price rise and its gradual roll out to customers according to their billing cycle. Adding 2.7 million net new subscribers every year can prove to be an enormous task if Sirius XM remains confined to the U.S., which is likely to be the case for the foreseeable future.

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

Notes:
  1. Liberty Media Proposes Transaction to Acquire all SiriusXM Shares, Sirius XM Press Release, Jan 3 2014 []
  2. Sirius XM’s SEC Filings []
  3. Sirius XM’s Earnings Transcript []
  4. Sirius XM’s Q1 2013 Earnings Transcript []