Own Sirius At A 16% Discount

SiriusXM is crushing it. After last week's earnings report, the stock shot up over 8% to an all time high. While many analysts and stock pickers love SIRI for its strong management, wide moats, and continuing growth, Drew Estes, a portfolio manager at Banyan Capital Management, says investors often overlook another stock that also shot up 8% after last weeks earnings: The Liberty SiriusXM Group (LSXMK). I sat down with Drew to discus the underlying strength of SIRI, but also why his preferred way of owning SIRI is via the John Malone tracking stock that trades at a 16% discount to its ~70% stake in SirusXM.

Luke Schiefelbein, SumZero: First, can you comment on SIRI’s recent earnings. Why is the stock up over 8%?
Estes: It is difficult to know what the market was “thinking” going into earnings, but one thing is clear: SIRI is firing on all cylinders. Revenues and EBITDA were up 9% and 12% respectively year-over-year on the back of strong subscriber growth and pricing power. Moreover, subscriber retention was strong and appears to be strengthening. This says a lot about the strength of SIRI’s business. Simply put, SIRI’s value proposition is resonating in the marketplace, and it is monetizing that value. This flies in the face of the bear case, which argues that free in-car entertainment will eat SIRI’s lunch. The facts simply do not support the bear case at the moment, and that thesis took another blow this quarter.

In addition, SIRI’s management team is proving that they are truly top-notch. Their initiatives in the used-car market are gaining traction, which opens up a new subscriber funnel that has proven difficult for SIRI to penetrate in the past. Furthermore, they are savvy investors and are owner-oriented, which is what investors want at the helm of a cash machine like SIRI.

Schiefelbein: What about SirusXM initially caught your attention as a value investor?

Estes: We always start with a business’s quality, and it is difficult to imagine a more attractive business financially. SIRI generates a high-margin, recurring revenue stream on the back of a subscription business model, and its business maintenance expenses are extremely low. Better yet, subscribers pay in advance, thereby funding all of SIRI’s capital needs. Together, this makes SIRI a cash machine that needs no capital to operate. When a business is that attractive, however, owners must worry about the business’s sustainability in the face of competition, and this is where the rubber meets the road.

As for us, we think SIRI is highly sustainable. Its entrenched relationships with OEMs and the fixed costs associated with launching satellites make it virtually impossible for a competing radio satellite company to arise. Free substitutes exist (e.g. terrestrial radio and streaming services), but SIRI’s differentiated content continues to resonate in the marketplace. So long as this remains unchanged, SIRI will continue printing money.

After we understood that, we looked at the price. SIRI was offering a conservatively estimated earnings power yield of roughly 5.5% at the time, which was higher than the earnings yield on the S&P 500. That is not a bargain basement price, but it is a very fair price for such a wonderful business. We wanted to buy SIRI as a result, and Liberty SIRI offered us a vehicle to do so at a 16% discount.

Schiefelbein: So what is The Liberty SiriusXM Group (LSXMK), and how did it come to be?
Drew Estes, Banyon Capital Management: Liberty Media Corporation (“Liberty”) is a holding company with various investments across the media and entertainment space spanning from Formula One to The Atlanta Braves. Liberty’s holdings are entirely unrelated, however, and the economics of each are vastly different. Management recognized this, and they created “tracking stocks” for each of Liberty’s primary holdings. One of which was The Liberty SiriusXM Group (“Liberty SIRI”, ticker NASDAQ:LSXMK), which consists of Liberty’s almost 70% ownership interest in SiriusXM (“SIRI”). By owning Liberty SIRI, investors reap the economic risks and rewards of Liberty’s ownership interest in SIRI, but they do not participate in Liberty’s various other investments (e.g. the Atlanta Braves).
Schiefelbein: Why does LSXMK trade at a discount to SIRI if it is essentially just a vehicle that holds SIRI shares?

Estes: There are numerous theories, all of which may contribute to the discount. First, indirect ownership is always inferior to direct ownership. Second, there could be negative tax implications to owning Liberty SIRI if a taxable transaction occurs. Third, SIRI’s share buybacks constitute almost 10% of the stock’s daily volume, which may create unnatural buying pressure. To us, none of these theories (or the others floating around) are very convincing, and they certainly do not justify the +16% discount to net asset value Liberty SIRI trades at. Therefore, Liberty SIRI presents an attractive vehicle for owning SIRI.

Schiefelbein: What will catalyze the market to realize the true value of Liberty SiriusXM and close the discount?

Estes: The most likely outcome is that Liberty SIRI ends up with greater than 80% ownership of SIRI as SIRI continues aggressively buying back stock. At that point, there are some tax-free transactions that can occur that will effectively eliminate the gap. If SIRI continues plowing
100% of its free cash flows into share repurchases, Liberty SIRI should breach the 80% threshold in one or two years.

Schiefelbein:. Is Sirius attractive to buy at today’s prices, outside of LSXMK?

Estes: SIRI is not as attractive as it was, of course, but it is not overpriced. It is now offering an adjusted earnings power yield slightly below that offered by the S&P 500, which is warranted for such a high-quality business.

In addition, SIRI has new opportunities before it. For one, SIRI’s technology and FCC licenses are perfect for a future with autonomous cars. In-car entertainment will rise, and who better to deliver that entertainment than SIRI? Second, SIRI has roughly 2x the spectrum it needs to deliver the content it currently offers. Once its satellites are upgraded, it can unlock that unmonetized value.

Schiefelbein: Won’t the proliferation internet access everywhere by Google, Facebook, and the communications industry constantly erode the value of SIRI?

Estes: That is a risk. As broadband modems are included in cars, the value of SIRI’s seamless distribution system will erode. It will take decades for this to permeate the auto fleet, however, and SIRI’s differentiated content and other assets still have tremendous value. Therefore, there are many years before this potential threat is on shareholders’ doorsteps, and it is unclear what impact it will have on SIRI, if any.

Schiefelbein: What key metrics should investors be paying attention to as your thesis matures?

Estes: Self-pay subscriber numbers are very important. If the numbers slip materially without a compelling reason, the SIRI thesis will be in question. In addition, keep an eye on Average Revenue per User for clues on how well SIRI’s products are resonating in the marketplace, but allow for fluctuations due to product mix. Lastly, watch adjusted EBITDA as an imperfect proxy for earnings power.

Schiefelbein: What were/are the biggest risks associated with the investment in your view?

Estes: The biggest risk that was/is facing SIRI is that free offerings begin eroding SIRI’s subscriber base. SIRI must continue convincing consumers that its content is worth paying for in the face of free substitutes. With that said, free offerings have been around since SIRI started, and they have yet to impact its business. Therefore, this risk seems materially overstated.