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Sirius XM
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==Sirius XM Offers Attractive Value as Auto Inventory Normalizes== The pandemic, worries about auto inventory, and the relatively weak guidance for 2022 have left Sirius XM's share price down over 15% from its prepandemic 2020 high closing price of $7.34. Morningstar's $8.25 fair value estimate implies a price/fair value around 0.75 and a 4-star rating. Morningstar's newer fair value estimate reflects the adoption of the Morningstar projections for new light-vehicle sales over the next five years. Overall, Morningstar projects revenue will grow by 5.6% on average over the next five years and the operating margin will improve to 28.3% in 2026 from 23.4% in 2021. Our model now includes more granular estimates for gross additions based on Morningstar's new light-vehicle sales projections along with Morningstar's estimates for used light-vehicle sales. While the new light-vehicle sales estimates assume that sales volumes return to prepandemic levels in 2023, Morningstar projects that the used market will take until 2024 to return to 2019 levels due in part to used vehicle pricing remaining elevated in 2022 and lower potential inventory from both fewer leases and an increase in lessees buying out leased cars due to constrained supply Morningstar expects the average annual volume over 2024-26 to be roughly equal to the volume from 2017-19. Morningstar projects that SiriusXM will continue to slowly improve its penetration in both the new and used markets over the next five years, hitting 84% for new vehicles in 2026, up from 81% in 2021, and 54% in used market by 2026 versus 51% in 2021. Some of the improvement in new vehicle penetration will come from the firm's push to have its radios placed in lower-priced cars. Additionally, the ongoing rollout of the 360L platform that combines satellite radio with internet streaming should also tempt manufacturers to add SiriusXM to more models. This growth in penetration will, in Morningstar's view, help offset an ongoing slow decline in trial conversion rates, which Morningstar forecasts will fall to 34% in 2026 for new vehicles from 37% in 2021 and 23% for used ones from 26% in 2021. Owners of lower-priced vehicles will likely be slightly more price sensitive than owners of higher-priced cars. An additional factor that will lower penetration rates is the increasing number of younger owners who likely already pay for a music streaming service and may not perceive a need for another audio offering. Morningstar does expect the firm to continue to add more streaming-only and aftermarket conversion customers over the next five years. However, Morningstar doesn't expect that SiriusXM will meaningfully push either offer, making the total gross adds from these channels relatively small. Summing Morningstar's expectations across channels, Morningstar now expects the firm to add almost 1.9 million more gross new customers over the next five years than in Morningstar's previous projection (Exhibit 12). While these additional adds are spread out over the next five years, the improvement is back-weighted with Morningstar's estimates for 2022 showing the least change. While churn has fallen by 20 basis points over the last five years, Morningstar expects that management will be willing to trade off further churn improvements for higher average revenue per user over the next five years, resulting in flat churn of 1.6% over the projection period. Coupled with Morningstar's new gross projections, Morningstar now expects SiriusXM to add 4.9 million net new subscribers over the next five years, up versus 4.4 million in Morningstar's previous model. However, Morningstar's higher new projection remains well below the 6.1 million net new additions that occurred over the previous five years. When combined with modest 3% growth in subscriber ARPU over the next five years, Morningstar estimates that SiriusXM revenue will expand 6% on average to hit $8.9 billion in 2026. On the gross margin side, Morningstar is only projecting a slight improvement to 62.2% from 60.8% in 2021. The largest component of cost of revenue for the satellite radio remains the revenue share and royalties expense that has averaged 25.2% of estimated gross revenue over the last three years. Gross revenue is defined as advertising revenue combined with subscriber revenue excluding connected vehicle services revenue. Morningstar expects that the firm is unable to gain leverage on this category over the next five years as its sound recording royalty rate is set at 15.5% through 2027, and the service pays fixed percentages for publishing royalties and on its revenue share agreement. SiriusXM should be more successful in gaining leverage on its direct programming and content costs and billing expenses. For Pandora, Morningstar expects total revenue will grow by 4% annually over the next five years to $2.6 billion in 2026. Advertising will continue to generate the vast majority of revenue as the service will likely continue to lag its much larger subscription peers on customer acquisition. Morningstar projects that advertising will expand by 4% annually and will represent 75% of Pandora's revenue in 2026, slightly above the 74% in 2021. The revenue improvement will be driven by average annual advertising revenue per thousand impression (RPM) growth of 7% as Pandora attracts more advertisers to both music and podcast content. Additionally, the AdsWizz service should help spark growth with improved digital ad insertion and cross-digital platform advertising campaigns. This growth will be partially offset by an ongoing decline in ad-supported listening hours, which Morningstar expects will drop from 11.6 billion in 2021 to just under 10 billion in 2026. The 10 billion listening hours in 2026 would be less than 50% of the 21 billion hours listened to in 2015 on the service. Subscriber revenue will expand slightly slower at 3% as the on-demand service remains an also-ran in a very competitive U.S. market headlined by Spotify, Apple Music, and Amazon Music. While Pandora is adding more podcasts to its service, Morningstar doesn't believe that those additions will be enough to differentiate the service, particularly from its much larger peers. As a result, Morningstar projects that the service will only add 145,000 net new subscribers annually over the next five years and will end 2026 with just over 6.9 million paying subscribers, well behind the Morningstar estimate of 82 million Spotify Premium subscribers in North America. Average revenue growth per subscriber will expand by only 1% on average over the projection period as Morningstar expects management will need to remain lower cost than the larger peers to attract subscribers. Morningstar expects that Pandora's gross margin will remain around 36% over the next five years as non-music content costs will continue to rise and offset the leverage that the service will get on its music costs.
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