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Sirius XM
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==Sirius XM Owns Two Different Yet Complementary Businesses== Over the last five years, Sirius XM Holdings has transformed itself from a pure satellite radio company to a more rounded audio platform that now includes streaming music and podcasts. This transformation was accelerated by the 2019 acquisition of Pandora and the 2020 purchase of Stitcher. Sirius XM operates two segments: SiriusXM, the satellite radio side, and Pandora, the pure streaming side of the business.1 While this transition has brought some positive changes, including a deeper focus on the streaming offering at SiriusXM, Morningstar remains unconvinced about the longer-term value of Pandora in a very competitive music streaming landscape. However, Morningstar believes that the issues facing Pandora and worries about the current auto supply constraints are overshadowing the strength of the satellite radio business. '''SiriusXM's Unique Programming and Service Drive Subscriber Growth''' SiriusXM is the much larger of the firm's two segments, generating 79% of revenue and 87% of gross profit in 2020. The SiriusXM brand nods to the history of satellite radio that launched in U.S. with the first broadcast in May 2001 by XM Satellite Radio followed four months later by Sirius Satellite Radio. Spending over $3 billion combined to launch satellites and build out infrastructures, the two competing firms were staring down bankruptcy in 2008 when they combined. While the combined firm still faced bankruptcy in its first year with revenue of $2.5 billion and an adjusted net loss of $441 million, the SiriusXM service quickly transitioned into a profitable and growing business over the last decade as seen in Exhibit 2. SiriusXM's content is primarily broadcast across the U.S. by a series of six satellites with two operating as backup for the other four. The satellites generally have relatively long lifespans and are depreciated over 15 years. The firm's newest satellite, SXM-8, was launched in June 2021 and placed into service in September. SiriusXM ordered two more satellites in August 2021 for delivery in 2024 and beyond. The signal from satellites can be broadcast directly into the satellite radio hardware or be enhanced by one of over 1,000 terrestrial repeaters that SiriusXM uses in urban areas to overcome signal blocking from tall building or high-density wireless networks. SiriusXM began to stream its programming over the internet prior to the merger of the two companies, and the service offers internet-only plans, as well. Content originates from all over the U.S., with the three main studios in New York City, Los Angeles, and Washington, D.C. SiriusXM and its predecessor companies have continuedly expanded both the breadth and depth of the programming lineup. The service now offers over 90 music stations that cover a multitude of genres, eras, and demographics along with multiple artist-branded stations, including Pearl Jam, The Beatles, Bob Marley, Eminem, Drake, Phish, Garth Brooks, and others. Sports offerings include the standard sports talk from ESPN, Fox Sports, CBS, and others as well as stations focused on specific sports and college conferences. SiriusXM is also the live national play-by-play radio home for the NFL, MLB, NBA, NHL, NASCAR, IndyCar, PGA, and the "Big Five Power" college conferences. Entertainment and comedy stations are headlined by Howard Stern, who has now been on the service for over 15 years, but also includes branded stations from The Today Show and Comedy Central. On the news side, SiriusXM offers simulcasts of every major cable news channel, including Fox News, CNN, MSNBC, and CNBC along with Bloomberg Radio, BBC World News, and several political talk stations. SiriusXM primarily generates revenue via subscriptions that make up over 90% of revenue for the segment. The vast majority of its stations are commercial free with ads only airing on certain non-music channels. The service offers a dizzying array of plans that range in price from $8 to $35 per month depending on the number and type of stations, streaming-only, in-car usage, and number of cars. A select number of the plans are shown in Exhibit 3. For the plans with music stations, the firm charges an additional fee that can range from $0.44 to $7.49 per month to cover U.S. music royalty costs. While the firm has added a number of lower-priced plans over the last five years, including streaming only ones, ARPU has increased steadily over the same period (Exhibit 4) due in part to the uptake of higher-priced plans, the growth in advertising revenue, and increases in the U.S. music royalty fee. The fee increases have not impacted net customer additions over the same time period. However, the firm is notorious for discounting its plans in order to retain customers, which has helped drive monthly churn down slightly over the last five years from a peak of 1.9% in the third quarter of 2017 to 1.5% in the same quarter of 2021. While consumers can sign up for the service directly, the majority come from the conversion of trial subscriptions of buyers and lessors of new and used autos. Every major automaker has signed an agreement with SiriusXM, but these agreements do not specify any specific or minimum targets for a number of radios installed. The trial length can vary from three months to one year. Despite this lack of commitments, the service has steadily increased its penetration within both new cars sold, now at 81% versus 67% in the first quarter of 2013, and used cars, now at around 50% versus 26% in the first half of 2015. Even as the number of trials has increased over the last decade, the conversion rate to paying subscriptions for new cars has only fallen from the mid-40% to the high-30% range, a respectable level given the substantial subscription cost. This continued strong conversion rate combined with increasing new and used car penetration and lower churn has helped drive strong net customer additions. The growth of SiriusXM's self-pay subscriber base is shown in Exhibits 5 and 6. '''SiriusXM Weathered the Pandemic Better Than Expected''' While many of SiriusXM's plans bundle together in-car and streaming options, Morningstar believes that in-car remains the primary location for most of the listening. Given this assumption, Morningstar viewed the lockdown restrictions and work-at-home at the start of the pandemic as a large potential negative, both in terms of churn and new customer additions, with current customers canceling the service and potential customers deciding to allow free trials to expire. Morningstar also expected the lack of commuting to keep consumers away from car lots, which would hurt the potential pool of trials to convert into self-pay subscribers. However, SiriusXM proved to be considerably more resilient during the first 18 months of the pandemic even as work-from-home and hybrid arrangements have continued. As shown in Exhibit 7, the service was hit hard in the first quarter of 2020, with less than 100,000 net additions for the first time since the first quarter of 2010. However, SiriusXM bounced back in the last nine months of 2020 to post a respectable 909,000 net adds for the year. The first nine months of 2021 remained strong with the service hitting its 2021 net additional guidance of 1.1 million by the end of the third quarter. The third quarter of 2021 was also the firm's strongest ever with over 616,000 net adds. Despite Morningstar's worries at the beginning of the pandemic, the paying subscriber base actually increased by over 2 million, or 7%, from the end of 2019 through third-quarter 2021. Over the same period, ARPU continued to increase, implying that subscribers were not trading down to cheaper steaming-only plans and that the firm was not offering steeper discounts than normal to retain customers. '''All Good Things Must Come to an End: Without Car Sales, Trials Dry Up in Fourth Quarter''' Despite the strong performance in the face of the pandemic, the service has begun to experience pandemic-related headwinds, through little fault of its own. Due to the ongoing chip supply shortage, new car inventory collapsed across the U.S. in the summer of 2021 (Exhibit 8).3 The U.S. auto industry began to see a decline in inventory in the front half of 2021 as manufacturers warned about the impact of the tightening chip supply on auto manufacturing. These ominous warnings started to be felt in the market as seasonally adjusted inventories fell throughout the year and the inventory-to-sales ratio fell below one month for the first time since the U.S. BEA began collecting data. That ratio continued to slide in the second half of the year, ending in December at 0.36 or roughly 11 days. Despite posting record net adds in the third quarter and meeting its 2021 guidance in only nine months, SiriusXM only raised its 2021 full-year guidance from "approximately 1.1 million net additions" to "over 1.1 million net additions," implying a very weak fourth quarter versus 2020 (407,000 net adds) and 2019 (341,000). On the third-quarter earnings call, management cautioned that SiriusXM would see 1 million fewer conversion opportunities in the fourth quarter than in the third quarter. Due to the inventory constraints, new car trials fell 21% in the third quarter versus the second quarter and used car starts dropped by 6% sequentially. The fourth-quarter results bore these worries out as SiriusXM only added 55,000 self-pay customers in the quarter, its weakest since the start of 2010. Citing the inventory shortfall and lower paid trials, management guided for only 500,000 net new paying customers in 2022, a level that would be more than 400,000 less than any year since 2009 when the newly merged firm faced bankruptcy. While the firm does not offer quarterly guidance, management believes that the majority of growth will occur in the second half of 2022. '''Returning to Prepandemic Sales Levels Will Take Until 2023''' While SiriusXM has suffered due to the recent downturn in car inventory, Morningstar expects these shortages to be resolved over short term, albeit beyond 2022. Morningstar's automotive equity team recently updated its five-year projections for light-vehicles demand on a regional and global basis (See the team's Observer, "Moats, Motors, and Markets 2022," published Feb. 25, 2022). For the U.S., new light-vehicle sales are projected to rebound strongly in 2022 to 15.7-15.9 million units, up 5.8% at the midpoint, well ahead of the recent low of around 14.6 million light vehicles sold in 2020 according to Automotive News. However, Morningstar's 2022 estimate remains well below the prepandemic level of around 17 million light vehicles sold. U.S. Autos Equity Strategist David Whiston expects inventory to gradually improve in the first half of 2022 but with no potential for major improvement until the second half due to the chip shortage. He projects that demand will continue outstrip supply through 2022, which should fuel even stronger unit growth in 2023, which he pegs at about 8.2% for a range of 17.0-17.2 million light-vehicles sold. Even with very modest growth in 2024-25 and a downturn in 2026, Morningstar expects light-vehicle sales to average slightly more than 17.0 million units over 2023-26 (Exhibit 9). According to Whiston, the factors driving this growth are varied but include healthy credit access, the lengthening age of the average American vehicle, the large number of safety and luxury features now available on new cars, and the growing appeal and availability of battery-electric vehicles. These factors are countervailed by a potential cap on the growth of leasing's contribution to new sales over the longer term, a ceiling on the length of loan durations, and the increasing size of monthly payments. Morningstar explores how this view of auto sales influences its thinking on Sirius in the valuation section below.
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