I have often been asked why I write so many articles pointing out the weaknesses of Sirius XM Holdings (NASDAQ:SIRI) if I am long the stock. There are multiple reasons, with one of those being that I had been able to make an above market rate of return by selling longer term covered calls against the position. Choosing option strike prices based above what I have perceived as fair value has allowed me to establish positions where I would be indifferent as to whether or not the shares would be assigned.
It can be argued as to whether I have been lucky, demonstrated common sense or remarkably prescient with my choice of strike prices. I write this because on most occasions the shares were not unexpectedly assigned, and on each of the two occasions when my core shares were assigned, the price subsequently retreated, allowing me to re-open the position. All along the way I have been pocketing the premiums. And, with these positions in tax sheltered accounts, there were no tax liabilities incurred.
However, it is more than just the use of options. I have watched Sirius move from a highly speculative stock holding with a high degree of risk offset by the potential for large gains, to a stock that I believe has much less opportunity for significant growth. Yet, even without significant organic growth, I was envisioning a company that would be able to control costs and increase subscription prices for its core of loyal subscribers. Now, however, I am concerned about whether or not the company has that pricing power.
ARPU
The simplest way to measure pricing power is with a metric the company has published for many years - Average Revenue Per User - or ARPU. Sirius defines the number as
...total earned subscriber revenue (excluding revenue derived from our connected vehicle services business), net advertising revenue and other subscription-related revenue, divided by the number of months in the period, divided by the daily weighted average number of subscribers for the period.
Furthermore, in the first quarter, the 10Q notes the following:
For the three months ended March 31, 2015 and 2014, ARPU was $12.26 and $12.18, respectively. The increase was driven primarily by the contribution of the U.S. Music Royalty Fee and the elimination of certain discounts offered to subscribers. The positive result was partially offset by growth in subscription discounts offered through customer acquisition and retention programs, and a shift to longer-term promotional data service plans with lower rates.
The increase is only eight cents, or 0.6%, from Q1 of 2014, and this was despite what could be considered some significant increases in the Music Royalty Fee ("MRF").
Music Royalty
On the plus side, we saw an increase in the Music Royalty Fee. This is a fee charged to self-pay subscribers to help offset the royalties Sirius pays for the rights to broadcast music to its subscribers. On January 5, 2015, that fee increased an average of 1.4%. While it is not revealed how the company calculated the average, a quick glance at the changes in the monthly fee shows that it ranged from 0% for many of the packages that were for "Additional Subscriptions (on the same Account)" to more than 300% on "A La Carte + Howard + Sports" where it rose from $0.50/month to $2.08/month on the First Subscription (while remaining at $0 on subsequent accounts).
The monthly fee for "Premier" rose from $1.87 to $2.64 (for the 1st) and from $1.38 to $1.94 (for subsequent), while "Premier Family Friendly" ($1.78 to $2.50 and $1.38 to $1.94), All Access ($1.87 to $2.64 and $1.38 to $1.94), and "All Access Family Friendly" ($1.78to $2.50 and $1.38 to $1.94) all showed sizable percentage increases. And yet, despite some of these significant increases, we see relatively little increase in the overall ARPU.
Discounts?
Sirius also stated that one of the reasons for the increase in ARPU was "the elimination of certain discounts offered to subscribers." While it is not clear which discounts were eliminated, a cursory examination of the web site suggests that the multi-year discount has been eliminated. This had been showing up on a page that touted the company's most popular packages, indicating the savings that could be achieved with bundled plans, annual plans and multi-year plans.
The description of the change in ARPU also notes that the increase was partially offset by the "by growth in subscription discounts offered through customer acquisition and retention programs." It should not come as a surprise to members of Seeking Alpha that the company has increased its use of discounts in a push to acquire and retain subscribers by offering "acquisition and retention program" discounts more widely. There are often comments by individuals about how they called to terminate their subscription, but renewed when they were offered deeply discounted rates to renew.
The last item addressed in the explanation for the change in ARPU was "a shift to longer-term promotional data service plans with lower rates." I suspect this refers to the announcements by several OEMs that they were including longer term subscriptions with the sale of their vehicles, as well as including traffic for up to five years.
Other
What is not discussed at all is the negative effect one would expect from the inexpensive packages targeted at Hispanics or fans of Joel Osteen. The Osteen package is $5.99/month as is the SiriusXM Español package, although the $50 annual rates that were once posted on the site appear to no longer be available. Since these low cost packages are not cited in the description for changes in ARPU, it would suggest that these low-cost, targeted programs have not been particularly successful or effective.
ARPU Decline
While the company cites the year over year increase by comparing the Q1 2015 ARPU to Q1 of 2014, there are several points that should be emphasized. ARPU averaged $12.38 for all of 2014, $0.12 higher than the $12.26 the company generated in Q1. That $12.26 is down an even more significant amount - $0.23 - sequentially from the $12.49 generated in Q4 of 2014. And, that $12.26 rate is only $0.03 higher than the company generated in calendar 2013. Is it a cause for concern? Here's what the 10k includes about the importance of ARPU:
Average monthly revenue per subscriber, which we refer to as ARPU, is a key metric we use to analyze our business. Over the past several years, we have focused substantial attention and efforts on balancing ARPU and subscriber additions. Our ability to increase or maintain ARPU over time is uncertain and depends upon various factors, including:
• the value consumers perceive in our service;
• our ability to add and retain compelling programming;
• the increasing competition we experience from terrestrial and Internet radio and other audio entertainment and information providers;
• our ability to increase prices; and
• discounted offers we may make to attract new subscribers and retain existing subscribers.
Our profitability could be adversely affected if we are unable to consistently attract new subscribers and retain our current subscribers at prices and margins consistent with our past performance.
Any company's 10K is notorious for discussing any and all risks, so these factors should be considered in that context. Still, in the past the company has been able to grow ARPU and subscribers on a somewhat consistent basis. There have been times when downward adjustments to the MRF have resulted in some unusual changes, but in general, ARPU has consistently moved higher. Last June I wrote an article about ARPU following a discussion on the topic by Sirius CFO David Frear discussed ARPU at the Bank of America Merrill Lynch Global Telecom and Media Conference in London. At that conference Frear said:
And I [get asked] about ARPU a lot and to be honest, it's not a measure I spend a lot of time focusing on. I do focus on the price structure of the business, but when you think about it, with 80% of households having two or more cars, if we were really successful, ARPU would drop, because we offer a multi-radio discount, which is below our current ARPU.
So we would love to end up with lower ARPU, but a lot more subscriptions in the long run.
The quote was part of a longer answer about increasing penetration of households with multiple cars but only one subscription. Since Sirius offers a discount on the second subscription, capturing an additional subscription with a family that has already demonstrated a willingness to pay for radio would seem to be easier than enticing a new potential subscriber to pay. Frear had also stated:
...a little over 20% of our subscribers are multi radio households. And therein I think lies the great opportunity because as you said, 80% of households have two or more cars.
Now only 20% of households have new cars only, so do not only the 80% have two or more cars, 80% have used cars in the household. So I think we have a great opportunity to take that 20% number on multi radio households towards the 80% over time.
Both CEO Jim Meyer and Hooper Stevens, Vice President, Investor Relations and Finance, have also discussed this issue. During the Q4 conference call Meyer stated:
I think an area of growth for us is, I think I'll get the statistic roughly right, which is I think close to 80% of the households in this country have more than one vehicle. And I think -- have more than two vehicles. And I think it's in the low 20% of our subscribers, have a matching subscription count.
And so you can argue either measurement, what you can't argue is how vastly wide they are, and that to me smells opportunity. And at least our premise is, the way to get at that opportunity is with simple, easier family plans. But we've got to walk through that carefully, so that it both benefits our ARPU -- I mean benefits our revenue and benefits our subscribers count.
Then, in March, Stevens responded to a question at the Morgan Stanley Technology, Media & Telecom Conference about marketing plans to address that opportunity:
We're trying those out. I don't know if we'll get to a sort of mass-marketed household plan this year. But I think we're thinking about the best way to structure that type of plan if we're to go by launching it.
If causes for the decline in ARPU were tied to the Osteen or Latino packages, the decline in ARPU could be considered more acceptable as the Osteen and Latino packages would likely represent incremental subscribers. A justification could also be made if a decline was caused by a surge in subscriptions for additional radios from current subscribers as these might be considered stickier subscribers likely to exhibit lower churn rates. Neither appears to have been much of a contributing factor as there was no mention of these factors in the 10Q.
Summary
Although option premiums have declined, I have remained heavily invested in Sirius because I had assumed the company had sufficient pricing power to grow revenues, even if subscriber growth faltered. In light of the dip in ARPU, that assumption may need to be reassessed. While I won't be in a hurry to unwind my option positions sell the underlying shares, I will be paying close attention to management presentations and looking forward to the quarterly results to be issued in July.
Disclosure: The author is long SIRI.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: In addition to my long positions, I have January 2016 $4 covered calls written against a small portion of my long positions and January 2016 $4.50 covered calls written against a majority of my long positions in Sirius XM. I also continue to make frequent short term trades on large blocks of Sirius XM on a regular basis. I may close the current call positions, open new call positions or buy or sell large blocks of Sirius at any time. I have no positions, nor plans to open positions, in any other company mentioned in the article.
