Sirius XM Holdings Inc (SIRI)

[BondGekko]

Sirius still has room to grow
It is remarkable how far the pendulum will swing. The excesses of the '90s have been replaced with a fairly significant amount of restraint and conservative behavior. As a result, corporations have been reluctant to spend and investors unwilling to risk capital.

Where is the imagination? More importantly where is the innovation? Very few it seems are stepping into the shoes of some of the great visionaries who created much of the wealth and productivity that we enjoy today.

Now corporate assets and investor risk capital are not to be taken lightly, but recent action seems to indicate that things may be overdone here. A quick survey of the corporate landscape yields nothing but a bunch of blue suits determined to squeeze every nickel and dime from intrinsic business with little real attention to expansion. The leaders of today's businesses all seem to be racing to nowhere.

It is a hopeless path. Indeed, tightening the purse strings at a time of overcapacity and recession is more than reasonable behavior, but to do so into perpetuity will do irreparable harm to the bottom line. If opportunity is not seized, a competitor is likely to move while others are standing still.

A great example of this is unfolding before our eyes. Apple Computer, regardless of the short-term impact on earnings, has rarely failed to invest the capital and brain power necessary to develop tomorrow's blockbuster product. The I-Pod, this year's must-have gift, was born out of that fertile environment of idea generation and a willingness to invest in the future.

Many companies may pay lip service to research and development, but very few have the vision necessary to produce results. Intel and Microsoft are just paying lip service. Both monopolistic businesses may very well spend millions on new products and service, but the long-term results of that investment have been stunningly poor.

That should be no surprise. These businesses would much rather milk the cow than take a chance on something new. God forbid that they fail.

As a result, their timid approach tends to be a follow-the-leader type of situation. That strategy of letting others fail and using massive leverage and size is much safer than going it alone.

Unfortunately for investors, such safety often results in mediocre performance. Such is evident in examining recent returns of Apple (AAPL, news, msgs), Intel (INTC, news, msgs) and Microsoft (MSFT, news, msgs). The difference in returns is startling and in sharp contrast.

Show me the innovators and I will show you the profits. Of course that is much easier said than done, and with the recent dearth of exemplary vision the task is even more difficult.

Recognizing that innovation comes at a cost is a great start in finding the stocks that will outperform in the future. For starters, it takes a great deal of investment at all stages of development. For some businesses, such an investment is prohibitive and results in large debt load, equity dilution and operating losses.

All of the above are frowned upon by Wall Street investors and tend to give rise to falling stock prices and low valuations. As time goes by and financial health deteriorates, confidence is lost. A company with vision often finds that vision when the future is bleak.

That is certainly the case with AAPL. Investors who recognized the short-term nature of the difficulties have been amply rewarded. A vision can take time to develop and successful investors must be patient for innovation to become realities that generate significant profits.

It is interesting to note that lack of vision is not unique to corporate chiefs. Wall Street and the financial press have been remarkably lacking in the insight category over the last few years. The absence of prescience is stunning when you realize that the proprietors of risk have closed up shop.

Well that is not entirely true, but take a close look at Sirius Satellite Radio (SIRI, news, msgs). A rapid rise in valuation is followed by an analyst downgrade followed by analyst downgrade followed by continued moves higher in the stock. Only then does the sheer weight of Wall Street finally have its impact when the last analyst comes out with a sell recommendation.

These short-term non-visionaries all believe the stock has moved ahead of itself. As if they alone can dictate what is an appropriate level of appreciation. Sure, I can accept the fact that the gamblers in the crowd are day trading on the volume and popularity of the shares, but accurately timing these moves is a lesson in futility and missed opportunity.

As future valuation is the only true arbiter of right and wrong, let's spend a few minutes assessing the prospects of SIRI. The main theme of the bears appears to be related to current valuation. With profit growth seemingly distant, the huge costs associated with content acquisition require a market penetration that could be insurmountable, especially considering that SIRI is behind market leader XM Satellite Radio (XMSR, news, msgs).

At its recent high of $9 per share and market cap of $14 billion, what formula could possibly exist to justify such excess? As is often the case with vision, these folks lack the ability to see the forest through the trees. It is staring them in the face and yet, 99% of the market experts seem to be missing the point.

It really is right there in front of them if they would just be willing to open their eyes. Let's assume that the total market for satellite radios is equal to the number of automobiles in circulation plus some percentage of the population interested in satellite radio at home. I think it is fair to say that number is quite large. I'll be conservative and put it at 250 million.

Now, let's assume that SIRI captures 10% of that market share, again being quite conservative. That results in a total of 25 million subscribers. At $13 per month in subscriber fees, not to mention the potential for spot advertising (make no mistake, advertising will be a part of the strategy at some point), total sales with such penetration comes in at $3.9 billion.

With break-even estimated to be approximately 15 million subscribers, SIRI should be quite profitable at that level. The only question then becomes how long does it take and what will the value of SIRI at that point.

As for the amount of time, I would guess that we are talking about a five-year period. Along the way, the company will be tweaking its model (as mentioned earlier, advertising revenue in a suitable format could be a huge boon for SIRI), passing milestones and improving its content. All of these things will be viewed as positives for the stock, pushing shareholder value to new heights.

The tricky part then becomes, what is a fair price for SIRI should it meet the above criteria. Well, let's take a quick look at other watershed-type businesses that have tapped massive markets. EBay (EBAY, news, msgs) and Google (GOOG, news, msgs) come to mind.

On a price-to-sales basis both eBay and Google trade for huge multiples, with eBay at 25 times and Google at 31 times. Both companies are profitable with profit margins of 24% and 7% respectively. Let's discount that valuation to say 10 times sales and apply that to SIRI. Doing so results in a valuation of $39 billion or $25 per share. Discounting that further by 20% brings me to my target of $20 per share.

Of course there is no guarantee that SIRI reaches its potential, but the odds appear to be in its favor. Its management team, with the addition of Karmazin, is rightly focused on content, having secured shock jock Stern and the major sport contracts (XM's attempt to compete by purchasing baseball was a mistake in my opinion -- baseball is a parochial sport with fewer teams or games with national interest).

Go ahead and believe that SIRI is ahead of itself, but if you are buying the shares for its long-term potential there is still money to be made here. I would even contend that my back-of-the-envelope analysis is too conservative.

It may take a few years for SIRI to reach those goals, but given its current share price patient investors have the potential to double their money. The risk is certainly high, but the reward may very well make it worthwhile. The fact that most of the professional community is now against us is actually a great contrarian indicator. I would buy SIRI here.


http://moneycentral.msn.com/content/Stratlabs/Round11/P103119.asp?Rating=10&PageID=103119

by

James Dlugosch