Why Sirius XM Could Face Sales and Margin Pressure for Years

Sirius XM Holdings Inc. (NASDAQ: SIRI) is a company that thrives on of new car sales. If you have had satellite radio and are not solely reliant on what you get for music in streaming or your library, then chances are pretty good that you won’t want to go back to just having old-fashioned FM/AM radio.

Shares of Sirius XM were lower on the first trading day of 2018 after JPMorgan’s Philip Cusick downgraded the stock to Underweight from Neutral. That’s the equivalent of a “sell” rating at other firms, and the $5.00 price target was well under the $5.36 prior closing price.

Tuesday’s downgrade also negatively affected shares of Liberty SiriusXM Group (NASDAQ: LSXMK).

Driving the downgrade was not so much the concern about “peak auto,” but the Copyright Royalty Board (CRB) decision in mid-December to increase the royalty rate by more than 40% to a rate of 15.5% from 2018 through 2022. This decision is expected to negatively impact margins for Sirius XM.

On top of the higher royalties that Sirius XM will have to pay for its music generating lower gross margins, Cusick sees problems coming in pricing flexibility and potentially sees slower subscriber growth. He also noted that Sirius XM is likely to pass on those price hikes to consumers over the coming year or two, which could pressure retention and successful post-trial migration into customers.

At the end of the third quarter of 2017, Sirius XM claimed to have approximately 27 million self-pay subscribers, with a grand total of approximately 32.2 million total subscribers and a total funnel of trial subscribers of approximately 8.9 million.

Sirius XM’s filing with the SEC in mid-December confirmed:

On December 14, 2017, the Copyright Royalty Board, or CRB, of the Library of Congress issued its determination regarding the royalty rate payable by us under the statutory license covering the performance of sound recordings over our satellite radio service, and the making of ephemeral (server) copies in support of such performances, for the five-year period starting January 1, 2018 and ending on December 31, 2022. Under the terms of the CRBs decision, we are required to pay a royalty of 15.5% of gross revenues, subject to exclusions and adjustments, for the five year period. The rate for 2017 was 11.0%. … The revenue subject to royalty includes subscription revenue from our U.S. satellite digital audio radio subscribers, and advertising revenue from channels other than those channels that make only incidental performances of sound recordings. … We are in the process of studying and evaluating the rates and terms announced by the Copyright Royalty Board. We also expect to evaluate changes in our pricing, including the amount of our U.S. Music Royalty Fee. We anticipate that the decision will result in an increase in our aggregate royalty expense on an annual basis beginning in 2018. We are not yet able to estimate the impact on our financial statements, although the additional royalty expense could be material.

A look at the Thomson Reuters consensus estimates shows that the consensus analyst price target for Sirius XM shares in the year ahead is $5.82. The $5.01 billion in annual revenue from 2016 is expected to grow to $5.42 billion in 2017, followed by $5.73 billion in 2018 and $6.05 billion in 2019. The normalized earnings per share of $0.16 in 2016 are expected to grow to $0.19 in 2017, $0.21 in 2018 and to $0.25 in 2019.

Sirius XM also has a chart issue for technicians of declining tops. After peaking above 45.80 in July and the start of August, Sirius failed to clear a lower hurdle of $5.80, and it failed to clear a lower hurdle of $5.75 in December.

What is interesting here is that the timing of the CRB decision was already known coming into this analyst downgrade. It came right at the same time that many Wall Street firms start to wind down on investment banking and on major research reports going into year’s end. The wording in Sirius XM’s SEC filing already telegraphed that the company’s aggregate royalty expenses would rise in 2018.

Sirius XM shares were last seen down 2.8% at $5.22 in mid-afternoon trading on Tuesday, January 2, 2018, with a $24 billion market cap. Its 52-week trading range is $4.40 to $5.89.

The Liberty SiriusXM Group shares were down 2.1% at $38.84. The 52-week range is $33.62 to $46.24.

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