Borrowing billions of dollars to try to build a business from scratch is always a bad idea. Companies tend to under-estimate expenses and over-estimate revenues in order to sell stock and debt at attractive rates. When investors and lenders get wise, they tend to stop putting fresh money into the business, often when it is only half built.
That was the ignominious fate suffered by Sirius Satellite Radio, which was forced to merge with rival XM Radio back in 2007. That effort simply combined two money-losing entities into one larger money losing entity known as Sirius XM Radio (Nasdaq: SIRI).
As a quick refresher, Sirius generates the bulk of its new customers by offering limited free-trails to buyers of new cars. The company is also aggressively pursuing the used car market these days. According to the Department of Transportation, there were more than 250 million passenger vehicles on the road in the United States in 2007. Sirius estimates that 27 million of those vehicles have factory-installed satellite radios. About 11.6 million of those vehicles have active subscribers at the wheel, with 15.3 million that are active radios but are not enabled.
Sirius believes that within five years, the number of vehicles on the road with factory-installed satellite radios will grow from 27 million to about 70 million, depending on auto sales trends during that period.
A year into the merger, Sirius XM subscribers were beginning to defect and debt-holders were threatening to take control and wipe out equity investors. By January 2009, shares fell all the way to $0.11, which usually implies an imminent bankruptcy filing. Indeed, a $175 million bond repayment was coming due in February 2009, but suddenly against all odds, things started to turn around. Uber-investor John Malone showed up with a $400 million rescue package to help beat back creditors. Within a few months, auto sales rebounded and subscriptions started to spring back to life. (Sirius generates new customers by offering them satellite radio in new cars).
Despite the boost, the company's customer base was still shrinking. It lost nearly 600,000 net subscribers in the fourth quarter of 2008 and another 400,000 in the first quarter of 2009. By the second quarter of last year, it lost another 200,000 subscribers. Subscribers were still leaving, but the trend appeared to be reversing.
Finally, by the third quarter of 2009, Sirius changed course and added more than 100,000 subscribers. During the next six months, 530,000 net subscribers signed on. Just this morning, Sirius XM announced that it signed up 583,000 net new customers -- more than twice analysts' forecasts and more than twice the rate seen in the prior two quarters. That helped push shares up +5% in Wednesday trading.
So is it safe to jump back into the water with this one-time highflyer? Yes -- with a caveat. The ride ahead will be bumpy as investors try to assess how and when Sirius can tackle it's still-mighty debt load, which tops $3 billion.
The company faces no major repayments before 2011, at which time it will need to come up with $340 million (roughly the current amount of cash on hand), or find a way to roll over that debt. Another $200 million comes due in 2012, but an eye-popping $1.8 billion debt burden will need to be addressed in 2013. The sharply improved subscriber numbers will surely help. Now that Sirius looks healthy once again, it could look to replace that debt with longer maturities at lower interest rates. And the operating outlook should only improve further as the company moves closer to those due dates.
As new cars sales continue to rebound up off of their lows, and as the installed base of used cars with installed satellite radios grows, Sirius' subscriber numbers should keep improving. Because this is a high fixed-cost business model, incremental new revenue should fall quickly to the bottom line.
There are two other factors worth noting: First, a five-year $500 million deal with Howard Stern expires at the end of this year, and a similar deal with NASCAR ends next year. Revenue and expenses will likely be altered by the outcome of any negotiations with those two entities.
Second, Sirius lost so much money in the last decade that it now has approximately $8 billion in state and Federal Net Operating Loss (NOL) carry-forwards. Those NOLs could be a substantial asset for any potential suitor that may look to acquire Sirius and shield its own profits from taxes.
Action to Take --> Sirius is clearly far healthier than 18 months ago. When the auto market eventually rebounds, growth should be sure and steady.
The improved outlook should enable smoother management of the company's substantial debt load. Look for analysts to upwardly revise their forecasts after today's subscriber news. Shares trade for about 10 times likely upwardly revised 2011 EBITDA targets. It's unlikely that shares will garner a multiple much beyond 13 or 14, at least while that debt overhang is there, but +30% to +40% upside from here looks attainable.