Open letter to BOA and Jonathan Jacoby

November 9, 2006

Dear Jonathan Jacoby and BOA Management:

In an analyst report that was in the form of an open letter to Sirius Management, I find several striking issues that should be addressed. While I can see a point for a desire for guidance on metrics, it is also very important to note that quite a bit of the information being sought can be obtained by using the information provided by Sirius, as well using some very reasonable assumptions can get you to a point where you can “value” Sirius Satellite Radio. In this sector there is always a temptation to try to compare Sirius and XM directly. Given the nature of many things such as the structures of deals, the point on the growth cycle, and the differing reporting methods, such a task is frustrating at best. With some metrics an average daily figure is used by one company while an average monthly figure by the other. Churn is calculated differently, ARPU is calculated differently, rebates are accounted for differently, SAC is impacted by in house sales force (non attributable to SAC) vs. and outsourced sales force (attributable to SAC). The list of differences is endless. These companies also have very different subscriber bases, and gross additions come from different channels. Anyone who has followed this sector understand fully well that there is a distinct difference in cost as well as retained revenue in a retail sub vs. an OEM sub.

Personally, I find this letter to be an example of the analyst trying to change one companies metrics to match that of another company. Simply stated this was a fools errand from the words “Dear Sirs”, and the author should have known this. With this in mind I find it odd that such a report was even issued. Anyone following the market should understand that there are certain metrics which are dictated by GAAP, and others are not. Non GAAP metrics are supplied to give flavor to particular aspects of the business, and these metrics can be used IN CONJUNCTION with GAAP metrics to assess the condition of the company.

Anyone who follows this sector is well aware that specifically segregated metrics can make one company look very good or very bad vs. the other. I find it most choices of the requests for changes most interesting in light of the last statement. In particular the churn request and the Gross subscriber request. I have outlined responses to the open letter written by Jonathan Jacoby. Johns words are in red:

Dear Sirs:

Please help. We appreciate the enormous amount of detail that you provide investors each and every quarter. But a few additional data points would go a long way toward illuminating the trends that define the company’s true potential. The satellite radio industry is at an early stage of growth, and the only way that investors can begin to assign a value to Sirius stock is if they fully understand how key metrics have changed over time. Please provide:

More information on gross subscriber additions by distribution channel (i.e., retail vs. OEM). Management has focused its commentary on net subscriber additions, but gross additions provide a better sense of relative market position.

I find it very interesting that gross subscribers has suddenly become the “important” metric for establishing market position. Up until Q2 of this year, neither company has broken out GROSS subscribers by channel. In fact, XM satellite radio used to not even bother to disclose gross subscriber numbers at all.

Further, how do you come to the conclusion that gross subscribers relate to market position? If Pepsi gave away a can of soda to everyone in America tomorrow would that make them the market leader because they had 300,000,000 consumers on day one???? Or would the market position be better defined by how many consumers Pepsi retains on day two, when the product was no longer being given away?

Additionally, GROSS subscribers do not pay the bills…...NET subscribers do. GROSS subscribers are great at making Subscriber Acquisition Costs (SAC) look low, but all to often people fail to consider the COST associated with the difference between GROSS and NET.

Another thing to consider that is perhaps most important is that all subscribers are not created equal. Some subscribers carry more value than others. Some pay more in monthly fees than others. Some have less revenue share associated with them than others.

Information on “car lot” subs. It is important for investors to have a better sense of the number of “car lot” subs as they need to be netted out in order to calculate a “pure” rate of churn.

Your quest seems to be seeking a definition of churn that is not used by either SDARS company. Given that churn calculations are not covered by GAAP, I am most curious as to what the “Jacoby Pure” methodology is. For example, should we back out the cars that fall off after a promotional period or not. Sirius counts them in Churn. XM does not. How do we consider the new XM method for OEM’s from Nissan, etc. They do not count these as subscribers at all until the consumer decides to keep the service after a promotional period. These subs are never counted in churn, but there are costs associated with them. The bottom line of course is that these companies have differing ways of doing things. Perhaps your energies would be better focused in running comparisons to the company itself.

Sirius disclosed the self paying churn as between 1.6 and 1.7% at the latest conference call. Perhaps you missed that segment. If so, the transcript is available here. Additionally Mr. David Frear discussed the issue at an investor conference in mid Q3. At that time he stated that the figure was about 8% of the subscriber totals in Q2, and that as a percentage it would go down. By the end of Q3, that percentage is likely between 6% and 7%, and after Q4 it will likely be in the 4% to 5% range. Simply taking 6.5% of 5,100,000 would give you about 335,000 cars on lots. Your own assumptions based on average days on a lot has the number at 268,000. Perhaps splitting the difference would be a reasonable idea. When you run your numbers please don’t forget to change your ARPU (see the next paragraph).

Another factor to consider is that you do not seem worried at all about the impact on ARPU. The subscriptions associated with these cars are deferred revenue. GAAP dictates that deferred revenue is a liability until the service that was paid for is delivered. Thus, these cars, while the help the subscriber numbers, are a liability to ARPU. The effect is that Sirius’ ARPU is negatively impacted. My question is why you are not also seeking “pure” (your term) ARPU. Does having an ARPU approaching $12.00 when you “back out” these subscribers not qualify as an important metric in your mind?

Lastly, you also need to consider that ALL of these cars will be sold, and ALL of these cars will become subscribers any way.

A break-out of churn by channel plus conversion rates for OEM promotional subs to “self-pay” status. It is difficult to estimate a rate of “pure” churn or accurately forecast total churn without detail on OEM promo subs.

You are seeking churn by channel and conversion rates. As a follower of this sector, I have heard Mel Karmazin express several times that he is perfectly comfortable if you use a range between 50% and 55% as a take rate. Now, knowing Mels character, and the way he sets and reaches targets and goals, you can rest assured that you are quite safe using a 52.5% take rate. Thirty-Three analysts cover this equity. Thirty-two of them seem to have found a way to base valuation. Even XM does not break out churn by channel, yet somehow you manage. This quarter Sirius gave you the self paying churn rate. Again, it was between 1.6% and 1.7%. You would likely be pretty safe using 1.65%.

Regarding churn by channel……Try doing a bit of legwork. You have the self paying churn, and you have the NET and GROSS OEM’s, and you have Mel Karmazin basically telling you to use a 52.5% take rate.

I would even submit that information relative to REVENUE SHARE would be more valuable. A revenue share of 50% is a stark difference from 35%, and revenue share impacts the bottom line for YEARS to come. Churn will happen no matter what. You minimize it by having compelling programming that creates VALUE to the consumer. Giving up revenue is a decision that should not be taken lightly.

More detail on how positive FCF will be attained. It appears that positive FCF only will be achieved with a significant reduction in working capital and modest capital spending in 4Q.

Attaing FreeCash Flow can happen in many ways. The business model has a certain scalability to it, and at the end of the day, what matters is how it is obtained. Consider that Mel K. has stated that there will be no more dilution, and that he has met or exceeded all goals, coupled with more cost efficient chipsets, and more initiatives that get cash to the bottom line such as Sirius Internet Radio, and additional revenue for premium bit-rates, business plans at $24.95 per month (look at what AMTC has been doing), and you can see how it is obtained.

We are increasingly confident in the pair trade – The valuation gap between XMSR and SIRI should narrow as we head into 2007. Sirius could struggle to make its year-end sub target of 6.3M and there is evidence that the industry is moving toward an OEM driven model.

You have spoken to the ‘pair trade” action plan for quite some time. It has not done investors very much good. In fact, it has been a losing proposition since the time you ever suggested it. Perhaps a new track would be a better recommendation. While there is indeed a valuation gap, a part of that was created by a string of "bad news" events for XM Satellite Radio coupled with Sirius Satellite Radio performing stronger than anticipate in retail share, and a ramp up in OEM's. the bad news portion of the XM downturn has mostly been remedied, and a certain bounce from that is a likely event. However, ample consideration should be given to the fact that 100% year over year growth seen at retail has belonged to Sirius. There is value in that, and that deserves consideration and reconition in this two company sector.

You yourself seem to feel that OEM’s are going to play a bigger part going forward. You may have missed it, but Sirius announced some impressive increases in the OEM channel, and even spoke to bigger penetration in DCX, Ford, Mercedes, and BMW. Of Note, DCX is going from 30% installs to 40% installs.

In addition, NASCAR is making the switch from XM to Sirius, and Sirius has already stated that they will market this to consumers.

I find it odd that in a post conference call write-up that you failed to bring up anything from the call…..Particularly given some of your comments in the letter.

Mr. Jacoby, there is value in this sector as a whole. Given the recent conference calls, many people have come to reconize it. Satellite Radio has tapped but only 5% of the population of this country, and BOTH companies are on their way to Cash Flow Break Even. Think of traditional valuation models, and base your valuations there. churn rates, take rates, and install rates are all good, but I am not aware of anyone who gets to a valuation based on them.

11/09/2006 10:53:00 PM

SSG Has Merged. You Can Read All Of The Latest SSG Content By Clicking Here

0 Comments:

Post a Comment

SSG is not a Financial Advisor. Read Disclosure: HERE

--------------------------------------------------------