Yale SCHOOL of MANAGEMENT - Analyst Reports

Transcription

Satellite Radio:
Does the Rabbit Win?
February 25, 2004
Yale SCHOOL of MANAGEMENT
David Lieberman
Francisco Lume
Ari Raivetz
d.lieberman@yale.edu
francisco.lume@yale.edu
ari.raivetz@yale.edu
Industry Summary
•We expect the number of subscribers to
reach over 8 million by 2010 and over 12
million by 2014 from about 300,000 today.
•We expect revenue to reach nearly $2
billion by 2014 from only $13 million today.
•Sirius managerial mistakes in the early
Sirius RATING:
SELL
Sirius Radio:
SIRI Price: 2.79
SIRI:
52 week Lo: 0.39
52 week Hi: 4.20
Market Cap: 2.81B
P/E: N/A
Profit Margin: N/A
EBIT Margin: N/A
ROA: -15.10%
ROE: -32.18%
EPS: -0.209
Beta: 3.954
stages of development cost them at least 12
months of time. This has given XM a
significant lead in the race and has forced Sirius
to play catch-up in a world where product
differentiation is quite small.
•Product differentiation is difficult.
Content, price, and advertising are quite
comparable. Only distribution strategies have
varied.
•Sensitivity analysis indicates revenue by
2014 needs to be as much as double our
estimates in order for Sirius to reach a position
where we would consider it a Hold.
•We are initiating coverage with a Sell on
Sirius Satellite with a target price of $1.78.
Yale School of Management, Satellite Radio: Sirius Satellite radio
Page 1
Revenue
To calculate revenue for Sirius we used a top down approach. We made market size projections
in our industry report, so we took that number and broke into two parts – XM and Sirius
subscribers. Our calculation of market share is discussed in detail below. Once we arrived at a
% for each company we calculated a projected number of subscribers, and based our revenue
projections off that number.
To calculate revenue, we had to make a number of assumptions. First, we assumed that price
remains constant at $12.99 for Sirius and $9.99 for XM. We discuss our reasoning for this
pricing dynamic in the market share section below. Second, we assumed that all new
subscribers are distributed evenly across the year. In other words, if some sign up in January
(paying 12 months) and some in December (paying 1 month), so on average (if signs ups are
distributed evenly across each month) then a new subscriber only pays 6 months of payments.
We applied the same principle to subscribers lost due to churn. A third assumption is that from
today through 2007 new subscribers pay only 9 months of fees due to promotional activity.
After 2007 we increased this to 10 months. A summary of our top line estimates for subscribers
and revenue compared to major analysts can be found below. We also offer our complete model
on the next page. Note that the average revenue per user (ARPU) is calculated from the revenue
and user projections:
Page 2
Page 3
Market Share:
One of the key drivers of our recommendation is the projected market share of Sirius vs. XM
going out into the future. As of December 31, 2003 Sirius had 260,000 subscribers, compared
to 1.36MM for XM Satellite Radio. A pie chart outlining the current industry market shares (as
of 12/31/03) is shown below:
The primary reason that Sirius
currently has such a small market
share is because they launched 9
months after XM. They were
originally supposed to launch first, but
experienced problems with their
chipset supplier, which caused a 12
month delay from their original launch
date.
There is no first mover advantage: Back in the late 1990’s when the Internet first began to
take off, the term “first-mover advantage” was created to describe a company that was entering a
previously “untapped” market. Today, when analysts talk about the satellite radio industry the
term often comes up as the explanation for why XM Satellite Radio will maintain its #1 market
share. We believe that this “first mover advantage” is myth, and that, in fact, there is the
potential for a “second mover advantage.”
The first mover theory has been disproved in countless industries and studies. A great example
is VHS (JVC) and Betamax (Sony), the two competing video-tape technologies created when the
VCR was invented. Sony was first to market, had a better technology, and had a proven
competency in mass-market consumer electronics production. Despite this, JVC was able to
capitalize on distribution relationships and other partnerships, and quickly took the #1 market
share position, eventually eliminating Betamax completely.1 While we acknowledge that the
VCR market has characteristics that are different from satellite radio, it still serves as a good
example that a “first mover advantage” does not always guarantee that you will remain on top of
the competition.
VHS and Beta Shares (by 1990, Beta under 1%)
120
100
Share
80
Beta
60
Source:
http://www.kellogg.nwu.edu/faculty/cap
ps/courses/Slides/M7NetworkExternalitie
sS2001.ppt#1
VHS
40
20
0
1974
1976
1978
1980
1982
1984
1986
year
There are a number of other examples of when being the “first mover” is not necessarily an
advantage. Pets.com, Webvan, Garden.com, and eToys are four of thousands of Internet
companies who moved first, but could not sustain their business.2 Ted Dintersmith, a partner at
1
http://www.kellogg.nwu.edu/faculty/capps/courses/Slides/M7NetworkExternalitiesS2001.ppt#1
“Moving First On A Winning Idea Doesn't Ensure First-Place Finish,” Katharine Stalter, October 7, 2002,
Investor's Business Daily
2
Page 4
venture capital firm Charles River Ventures, says that although there are advantages to arrive
first to market, it does not mean the product is best. "The first one out makes the mistakes. A
smart strategy might be to follow second-mover advantage or best-mover advantage.”3 eBay is
often touted as the ultimate first mover, but its own spokesman, Kevin Pursglove, says, “In the
long run customer experience has mattered more than being one of the earliest auction sites."4
Geznius Hidding (Loyola University - Chicago) and Jefferey Williams (Carnegie Mellon
University) recently conducted a study to determine whether there are first mover advantages in
various technology products.5 They analyzed 19 IT product categories that enable B2B
eCommerce (and 6 that enable B2C eCommerce) and found that in at least 16 out of 19 cases
(and 0 out of 6 cases for B2C) there was no sustained first mover advantage.6 A chart listing
their results is shown on the following page.
The fact is, many people believe that going second or later provides an advantage. The obvious
one is that companies see the mistakes made by the first mover, attack them directly, and do not
make those same mistakes. Other advantages include lower R&D costs through reverse
engineering, resolution of technological or market uncertainty, and incumbent complacency.7
Despite these historical examples and supporting research we do recognize that industries are
different, and each has its own characteristics which make it more or less susceptible to first
mover advantage. In satellite radio there were originally very high switching costs, which
usually would favor the first-mover. However Sirius recently announced that in conjunction
with Soundgate, they have developed a translator which, for $150, will allow any XM equipped
GM or Honda owner to switch to Sirius.8 The addition of this and other FCC-mandated
interoperability devices will significantly lower switching costs and increase competition.
Satellite radio is also targeted mostly to consumers, so brand strength is significant, which
would also favor the first mover. We do not dispute that XM is clearly the leader in name
recognition. However, we believe that because the distribution model currently does not allow
free consumer choice, the importance of brand is lessened. In addition, Sirius has recently
launched a number of advertising campaigns to rapidly build its brand which we will discuss
later in the report.
3
Ibid
Ibid
5
http://econ.gsia.cmu.edu/gsiadoc/pid7153.pdf
6
Ibid\
7
http://www.kellogg.nwu.edu/faculty/capps/courses/Slides/M7NetworkExternalitiesS2001.ppt#1
8
http://www.Sirius.com/servlet/ContentServer?pagename=Sirius/CachedPage&c=PresReleAsset&cid=1074
263715098
4
Page 5
Source: 1 http://econ.gsia.cmu.edu/gsiadoc/pid7153.pdf
Page 6
If first to market is not enough to keep a #1 position, why do analysts believe that XM alone will
continue to dominate the market for the next five to ten years? It really boils down to
determining the subtle differences between XM and Sirius. We will look at this from four
perspectives: Content, Price, Promotion, and Distribution.
Content:
Sirius likes to call itself a “premium provider” of satellite radio service. Originally, Sirius was the
only company to offer all of its music completely commercial free, but XM recently announced
that they will also have no commercials on its music stations. Both companies offer every
imaginable genre of music, XM on 68 channels and Sirius on 60. Based on our analysis, we
determined that the content offered by each company, both music and non-music, is essentially
homogenous. A chart mapping out each company’s non-music content partners is below.
Sports
Sirius views its relationships with the NBA, NHL, and NFL as key differentiators from XM. In
addition, it has recently signed partnerships with a variety of niche content providers including
Dow Jones/Wall Street Journal and a gay/lesbian station. If we look at the satellite television
market, DirectTV’s partnership with the NFL has been the most important factor in their
success to date. However, radio and television are incredibly different vehicles of
entertainment, especially when it comes to sports. In our view, the relationship with the NFL
will help Sirius from the perspective of brand recognition more than to differentiate Sirius from
XM. Satellite Radio is most useful for drivers, particularly commuters and long-distance
travelers. Yet, football is played on Sundays when most people are not in their cars. In addition,
football is a made for TV sport (which is why DirectTV has had so much success with it) that
resolves around seeing bone-crunching tackles and amazing touchdown catches. With only 16
games per year, people are much more likely to find somewhere to watch it on television and
often visit a local bar to view a favorite team if the game is not offered on traditional cable. As
such, we do not view the NFL deal as a significant differentiator between Sirius and XM.
Sirius will also be creating "The NFL Radio Network," with year-round coverage of the league,
but, again, we have a hard time believing this will have enough teeth to set them apart.9 In fact,
of the four major US sports, baseball (which has a non-exclusive deal with XM), is the most
likely to be listened to on a radio. The game does not move as quickly as the other three, and is
therefore easier to describe with words. Traditional listeners of radio have often listened to an
afternoon baseball game. Still, even with baseball, the combination of the other three major
sports will be tough for XM to overcome. As such, from a sports content perspective, we will call
it a draw.
9
64
Page 7
News and Entertainment
There are very few differences between XM and Sirius in news and entertainment stations. They
share a large number of content partners, and none of the exclusive relationships really stand
out. The only differentiator would appear to be XM’s recent announcement of its instant traffic
and weather service. However, on January 7, 2004 - before XM’s announcement, Sirius
announced plans to offer real-time traffic information to subscribers beginning in January
2005.10 The service will not be launched for 12 months because Sirius is integrating it with GPS
technology to include navigation and weather features. Their goal is to offer personalized traffic
and other services for an additional fee. In the short run, XM’s traffic will help it maintain
share, but in the long run, both will offer very similar products.
Our analysis leads us to the conclusion that the companies offer essentially homogenous
content. As a result, we do not believe that enough consumers will choice XM or Sirius based
on content to have a significant effect on market share.
It is worth noting that there is one possibility, rather, one person that could give XM or Sirius a
significant edge in the content arena: Howard Stern. Howard Stern has over 20 million loyal
listeners11, making him the #1 or #2 radio talk show host in America, depending on who you ask.
Stern has mentioned numerous times on his show then when his contract expires in two years
he might consider moving to satellite radio, where he could work with less commercials and no
censorship. If that were to happen, and the only way a listener could get the Stern show was to
subscribe to that satellite radio provider, then it would be a tremendous advantage for whoever
signed Stern. However it is impossible to predict which satellite radio company would sign
Stern, so we cannot say how this will affect the shares of Sirius or XM today. But, this is quite
important to note as we feel that there is a significant chance that he could switch.
Price:
As mentioned above, XM offers its service for $9.99/month while Sirius offers it at $12.99
month. However, in response to XM’s removal of all commercials from its music stations, Sirius
instituted a promotion offering 3 months free when customers sign up for one year of service.
This effectively brings the price down to $10.24/month, in line with XM’s $9.99 price. Of
course, after the first year the service the price goes back to $12.99, but for the first year, at least,
price is essentially the same between the two firms. As such, we believe that the higher price
charged by Sirius will slow their ability to gain market share in the short-term (6-12 months).
We also believe that over time the pricing will remain constant. It will be difficult for pricing to
change much. If the companies were to raise their prices by any significant amount, then the
FCC would likely step in and sell new licenses, unless it was done to allow these firms to reach
profitability. In addition, XM and Sirius have very little incentive to lower prices because it is
very likely to cause a negative reaction by the other firm. If we had to speculate on any change,
we would anticipate that XM might raise prices in order to match Sirius. This likely wouldn’t
have a significant effect on Sirius’s share as it would just make the companies even more
homogeneous.
10
273
11
http://www.self-gov.org/stern.html
Page 8
Advertising:
As mentioned earlier, arriving second to market puts Sirius at a disadvantage from the
perspective of name recognition. They have recently embarked on a number of promotional
activities to try to improve upon this weakness. Their deal with the NFL includes a variety of
cross promotional activities which should help improve Sirius mindshare, much as it did for
DirectTV. Sirius has also launched a large television commercial campaign on the major
networks, including the “Pamela Anderson Car Wash” promotion which was seen during the
Super Bowl. Another strategy revolves around using celebrity musicians and concert events to
promote the Sirius name. They have broadcasted live concerts for a number of bands, and
promoted their trade show events with special appearances such as Lynyrd Skynyrd at the
recent consumer electronics show. A third strategy Sirius is using involved their recent
partnership with Radio Shack and The Dish Network. The three companies plan to work
together to provide advertising and marketing support for their satellite entertainment alliance.
This includes print and radio ads, monthly promotional flyers and inserts to customers, in-store
displays, sales training, and other promotional activities.12
While there will likely continue to be significant expenses associated with these promotional
activities, we view them as mandatory for Sirius in order to stay competitive. We also feel that
the promotional costs can be controlled, as evidenced by the fact that Q4 ‘03 subscriber
acquisition costs (SAC) registered $222, down significantly from the $522 dollars registered in
Q3 ‘03. In its Q4 earnings conference call management noted that $150 of its SAC was related to
ongoing SAC cost (down from $198 in 3Q) and $72 was related to introductory promotions
(down from $127 in 3Q).13 We view this as positive sign that Sirius’s marketing dollars are being
spent more effectively and some its marketing partnerships are beginning to gain traction. In
2004, management expects that total SAC will be below $200, with the increased promotional
activity aided in part by the introduction of cheaper next generation chipset products.14
Even with all of the cost effective promotional activity, we view Sirius’s distribution strategy as
the key differentiation between it and XM.
Key Takeaway: Advertising will help make Sirius competitive at the point of sale (so
consumers know they have a choice), but it will not make consumers choose Sirius, because it
does not change the fact that their product is no different than XM’s.
12
337
13
JP Morgan Securities, 1/29/04, Sirius Satellite Radio, Good News/Bad News Quarter and Outlook, Vinton
Vickers
14
Ibid.
Page 9
Distribution:
With content and price essentially the same, and advertising likely to keep Sirius on par with
XM, what is the difference between these two companies? We feel that the key is distribution.
Both companies distribute their product primarily through automotive manufacturers. We took
a look at the deals XM and Sirius have with auto manufacturers, the number of cars each of
manufacturer sold in 2002, and the average income level of consumers who buy that type of car.
As you can see from the chart to the left,
Sirius and XM have exclusive relationships
with manufacturers representing what
appears to be an equal share of the US
automotive market. A closer look reveals
that – in a market where all cars sold were
either XM or Sirius exclusive brands – XM
would have a 55% market share, to Sirius’
45%. It should be noted that XM’s
relationships with Honda and Toyota are
not exclusive, so there is a risk of them
losing this lead. However if we assume
things remain the same, then this is a
significant advantage for XM, and an
important piece of data in predicting future
market share.
We also analyzed both Sirius and XM
through an evaluation of their potential
buyers. This can best be explained through
example. Sirius has a deal with BMW,
whose buyers we would classify as those of
the highest level of income. Therefore, that
group received a 3 (out of a possible 3).
At the opposite end, Ford denotes a 1, indicating the lowest level of income for the buyers.
Obviously, this is quite general and broad, but it provides a reasonable indication of the quality
of the consumers within each group.
Given that the level of conversion is likely to be higher with those of higher income groups, this
analysis is valuable. Our overall averages show that that Sirius targets a much higher end
consumer than XM (2.25 vs. 1.33), which should prove to keep churn rates down and trial
customer conversions higher. Sirius has already started to focus on higher end cars. In October,
Sirius announced that its services would be available as a factory installed option in the 04
Dodge Durango15, and December they announced that BMW will be rolling our their service as
standard feature in all 5 series sedans.16
The two pieces of data discussed above were the only pieces of hard evidence we used to
compute market share. As of 12/31/03, XM had one million more subscribers than Sirius. Our
15
050
16
935
Page 10
first key assumption is that our industry projections are correct. Second, we assumed that
because the products are so heterogeneous that both companies will acquire the same number of
customers over the next 10 years. That left with a 2014 estimate for XM of 15.97M subscribers,
and Sirius of 14.97M subscribers. This was our baseline market share.
We next took into account that XM has a 10% market share lead with auto manufactures.
Finally, we subtracted 300 market share basis points from XM for its weaker customer
demographics. The resulting market shares left Sirius with 45% of the market in 2014. To
arrive at numbers for each year we made simple assumptions that showed Sirius’s share
increasing at a decreasing rate. A chart detailing our market shares compared to various analyst
projections can be found below:
It is important to look not only at the number of relationships each company has with
automotive manufacturers, but to evaluate how good they are at developing those relationships.
To date, XM has been the clear leader in this area, but Sirius has gained some recent traction.
Overall, Sirius had 50 car models at year end 2003 with the number of models offering Sirius is
expected to grow to 80 by year end 2004. More importantly, the number of factory installed
radios should quickly climb from only 16 today. In its earnings conference call, Sirius
management raised the number of expected factory install programs to 50 from 47, with 27
announced as of 1/30/04.17 In addition, Sirius recently announced that DaimlerChrysler will
offer its service as a factory installed option on 8 additional models by the end of 2004.
Mercedes is launching 9 factory install programs, with the first ones beginning in March.
Additionally, BMW is extending its factory installed option program to the complete 5 and 7
series lines (with a 1 year prepaid subscription bundled in the price of the vehicle).18 Although
17
WR Hambrecht, “SIRI Q4:03 Below estimates, Subscriber Outlook Intact,” 1/30/04
JP Morgan Securities, 1/29/04, Sirius Satellite Radio, Good News/Bad News Quarter and Outlook, Vinton
Vickers
18
Page 11
they will likely not see the results of these new installs until late 2004 or 2005, it is a sign that
management is focused on developing these relations to match XM’s efforts in this area. Despite
this traction, we feel that Sirius’s progress is accurately reflected in our industry projections and
will have little impact on market share.
While it was not included in our market share calculations because there is no
quantifiable data to support it, there are a number of other important factors that
must be considered when predicting future market shares. Many of these factors
are discussed in the Potential Upsides section. In addition, our additional
sensitivity analysis takes into account other opportunities in the market.
Page 12
Financial projections
Our model is a two-stage APV model. The first stage represents the major growth of the
company, whereas the second stage holds a significant lower growth rate. Through the first
stage, we expect the company to expand incurring significant costs. This is related to revenue
enhancement costs and operational inefficiency typical in the first few years of a new industry.
By the beginning of the second stage we expect that Sirius will reach sustainable net margins
and that there will only be slight improvements around EBITDA margins.
On the first stage we used the street numbers to estimate costs. We used a variety of analyst
reports to come up with some composite figures19. For variable costs estimation such as
customer service and billing costs, sales and marketing costs, and SAC costs, we used the
revenue percentage used on the street too. Through our revenue projections for Sirius, EBITDA
margins will be around 15% through the second stage with slight improvements due to reduced
marketing and acquisition relative costs.
Sirius has invested in 4 satellites worth around $250 Million each. Three satellites are in orbit
and one is in storage. This one will replace any other that goes down. Other assets such as
network repeaters, studio equipment, furniture, satellite tracking facilities, customer care and
billing facilities add up to around $150M. Satellites are depreciated over 15 years and other
assets are depreciated over 5 years. Depreciation expenses will be around $95M/year. We
estimate that CAPEX will be very high in 15 years with another investment in 4 new satellites.
Every 5 years we expect that there will be an investment of $150M in other assets. We do not
expect that there will be any other significant investments in property or equipment as Sirius
has its operation base ready to do business.
We used APV in our financial model. For the first stage we have used the current historical Beta
of 4 with a risk free rate of 4% and an equity risk premium of 6%. With the current capital
structure that leads us to an unlevered Beta of 3.8. For the second stage, we have used Dish
Network as a comparable for future Beta considerations. In the second half of the model, we
have used a Beta of 2 and a and an unlevered beta of 1.8. Perpetuity debt was assumed constant
at $100K from year 2014 on.
We performed a sensitivity analysis around the two major factors: perpetual growth rates and
revenue growth. The share price is sensitive to these two variables as given in the chart in the
sensitivity analysis. Notice that for reasonable estimations of these variables, the stock price is
still below today’s share price. Our estimations are that the share price should be around $1.78.
19
SG Cowen: Sirius Satellite Radio Market Perform (3), January 29, 2004, Q4 Results: SIRI Primes the Pump,
Subs Beginning to Flow. JP Morgan Securities, 1/29/04, Sirius Satellite Radio, Good News/Bad News Quarter and
Outlook, Vinton Vickers
Page 13
Page 14
Page 15
Page 16
Comparables
Because satellite radio is such a new industry there are very few direct comparables. As a result,
we felt comparing Sirius across multiple industries would provide a unique perspective into the
potential for growth. We compared Sirius to Coke, AOL, and the Dish Network from a number
of different perspectives.
ARPU: Dish Network vs. Sirius.
There is a large difference in comparing average revenue per user (ARPU) of Dish Networks to
that of SIRI. Currently, SIRI charges $12.99 per month, while XM only charges $9.99. In the
most recent quarter, Sirius reported that their average revenue per user was only $8.95.20
Satellite television, on the other hand, is much more expensive. EchoStar has a basic package
for $29.95. However, with the additional premium features that they offer, their ARPU is now
nearly $51, almost 6 times higher than Sirius21. ARPU comparables of Dish Networks and Sirius
is indicated on the graph on page 19 by the dotted blue box.
Given that the ARPU for satellite radio is likely to hover between $9 and $12, subscriber growth
for Sirius will have to be quite substantial in order to even equal the success of Dish and other
satellite television providers.
Churn: Dish Network vs. Sirius vs. AOL
Churn rates between Dish Network and Sirius and AOL vary a fair amount with monthly churn
rates of 1.57%22, 1.7%, and 3.5% respectively.23 Sirius has had a fairly volatile churn rate. For
Sirius, in the first 9 months of 2003 monthly churn rates were hovering around 1.5%. However,
in the 4th quarter, they spiked to 2.3%. Sirius claims that the jump is a result of the clean-up
from credit card charges from several months back. They issued new churn guidance of 1.7% for
the future24. In terms of pricing, Sirius is more similar to AOL, but AOL has a large number of
competitors that offer lower prices. Still, it would be fair to estimate a 3.5% churn rate as the
upper end, since Sirius users do not have the same number of competitive options.
Dish and satellite TV should represent the low end of churn estimates. Satellite TV is not able to
provide its services with the sale of every new house. Consumers must individually call to set up
a time for installation to take place. Therefore, the subscribers willing to make that effort are
much more likely to remain as consumers resulting in a lower ongoing churn rate. As a result,
we see the churn for Sirius as in between the two settling around 2.3-2.5%
Churn: XM vs. Sirius
XM, by comparison, has continued to claim monthly churn rates in the very low 1% range. But,
XM’s remarkable 1% monthly churn rate may be extremely misleading to current street
estimates. A large percentage of XM’s installed base is in GM models. However, GM had been
20
http://money.cnn.com/2004/02/03/technology/techinvestor/lamonica/
Ibid
22
http://10kwizard.ccbn.com/fil_list.asp?TK=Dish&CK=1001082&FG=0&alld=ON&LK=0000FF&AL=cc0033&V
L=cc0033&TC=FFFFFF&SC=ON&DF=OFF from 11/10/03
23
http://www.businessweek.com/magazine/content/02_41/b3803066.htm – this data is deliberately taken from the
middle of 2002 as the dial-up Internet market today is not a comparable
24
SG Cowen: Sirius Satellite Radio Market Perform (3), January 29, 2004, Q4 Results: SIRI Primes the Pump,
Subs Beginning to Flow
21
Page 17
subsidizing the cost of offering its drivers by paying for the first 3 months of free satellite radio.
Given that most subscribers have come on during the past 6 months, it will be another year
before we begin to see the conversions and churn rate from this group. This is likely to be a
portion of the large gap between XM and Sirius churn rates, but may also indicate a slight
advantage for XM as well.
One of our largest concerns about Sirius, and satellite radio in general, is that the initial
honeymoon period will begin to end over the next 12 months. Today, buyers of satellite radio
are mostly wealthy and highly tech-savy buyers. As standard users begin to infiltrate
subscription levels, monthly churn rates should start to climb. In fact, as noted above, there are
indications that this has already begun. Given that monthly churn rates are edging upwards for
Sirius in comparison with both Dish and XM, this should be monitored closely. The negative
impact on the DCF model and valuation would be significant negative. Below indicates our
projected level of subscribers in the industry based on a variety of different monthly churn rates.
In our current model, we believe that churn will increase for Sirius to nearly 2.4%.25
Exhibit: Industry Subscriber Levels Based on Churn
Churn Rate
1.5%
1.7%
1.9%
2.1%
2.3%
2.5%
Subscribers
37.08
34.04
31.33
28.92
26.76
24.82
Price/Sales: Dish Network vs. Sirius
Typically, we would not consider a price/sales ratio a serious measure of overvaluation or
undervaluation. However, it is interesting to view the substantial premium that Sirius is
currently trading in comparison to where Dish Networks was trading in the 1990’s as they were
building out their own network.
The highest the price to sales ratio reached for Dish was 16.88 in 1999. However, the stock still
hasn’t returned to that split adjusted level. In fact, Dish is still trading at a 30% discount to that
level. Sirius, is currently trading at a staggering 30x 2004 estimated revenue (42x street
estimated revenue) and over 13x 2005 our estimated revenue. While this certainly does not
pinpoint any precise level of valuation, it does indicate that at the relative points in the products
development, Sirius is trading at a much higher level relative to sales. Expectations, however,
for Dish Networks were substantially met, while Sirius has yet to deliver. For this reason,
trading at such a large level indicates that the market largely believes that Sirius will be
successful. While we agree that Sirius will likely be a successful company, this does not justify
this type of multiple at this juncture and leaves little room for a reasonable equity return.
25
Briefing.com, Robert V. Green 2/12/04:XMSR: Customer Acquisition Costs Still Key
Page 18
Sirius Satellite Radio
Dish Network Subscriber Comparison
DISH
Subscribers
Growth
Sales (millions)
Revenue per Subscriber
Adjusted Year End Stock Price*
Market Cap. (millions)
Price/Sales
Satellite Radio
SIRI
Subscribers
Growth
Sales (millions)
Adjusted Year End Stock Price *
Price/Sales
XM
Subscribers
Growth
Sales (millions)
Adjusted Year End Stock Price *
Price/Sales
Market
SIRI Share
XM Share
Total
Sources:
1996
1997
1998
350,000 1,040,000 1,940,000
197.1%
86.5%
199
35.50
477
38.50
983
39.25
2.75
1,526
7.67
2.09
1,160
2.43
6.05
3,357
3.42
2002
2003
2004E
11,821
261,061
2108.5%
12.9
8.95
3.16
1,000,000
283.1%
98
0.8
0.64
1,360,000
291.9%
20.20
2.69
332
16
3.3%
96.7%
358,821
2,800,000
105.9%
91.70
215
26.29
3,929
43
3,240
15
16.1%
83.9%
1,621,061
26.3%
73.7%
3,800,000
2.962
21.68
1999
3,410,000
75.8%
2000
5,260,000
54.3%
2001
6,830,000
29.8%
2002
8,180,000
19.8%
1,603
42.71
2,715
45.33
4,001
49.32
4,821
49.17
48.75
27,050
16.88
2005E
22.75
12,623
4.65
2006E
27.47
15,242
3.81
2007E
22.26
12,351
2.56
2008E
2003
50.79
33.99
18,860
2009E
1,986,951
2,943,606
4,236,135
5,727,329
7,144,472
232
369
538
767
984
4,222,271
5,466,696
6,911,589
8,241,766
9,470,579
379
528
675
849
1,003
2,950
30
347,000
SIRI Current Price:
XMSR Current Price:
13
32.0%
68.0%
6,209,222
35.0%
65.0%
8,410,302
38.0%
62.0%
11,147,724
41.0%
59.0%
13,969,096
43.0%
57.0%
16,615,050
*As given by Yahoo http://finance.yahoo.com/q/hp?a=08&b=13&c=1994&d=01&e=15&f=2004&g=m&s=xmsr
*As given by Yahoo http://finance.yahoo.com/q/hp?s=SIRI&a=08&b=13&c=1994&d=01&e=15&f=2004&g=m
*As given by Yahoo http://finance.yahoo.com/q/hp?s=DISH&a=05&b=21&c=1995&d=01&e=15&f=2004&g=m&z=66&y=66
http://10kwizard.ccbn.com/fil_list.asp?&TK=DISH&CK=1001082&FG=0&SC=ON&TC=FFFFFF&LK=0000FF&AL=cc0033&VL=cc0033&st=2&page=3&extras=0 10-K on 3/4/03
http://10kwizard.ccbn.com/fil_list.asp?&TK=DISH&CK=1001082&FG=0&SC=ON&TC=FFFFFF&LK=0000FF&AL=cc0033&VL=cc0033&st=2&page=21&extras=2 on 10-K 3/17/99
http://www.xmradio.com/newsroom/screen/pr_2003_01_08.html
http://www.xmradio.com/newsroom/screen/pr_2004_01_07.html
http://finance.lycos.com/qc/news/story.aspx?symbols=NASDAQ:SIRI&story=200402132207_RTR_N13283346
http://www.edgar-online.com/lycos/quotecom/glimpse/glimpse.pl?sym=SIRI
http://finance.yahoo.com/q/is?s=XMSR&annual
http://biz.yahoo.com/ap/040212/earns_xm_satellite_2.html
http://finance.yahoo.com/q?s=dish
http://money.cnn.com/2004/02/03/technology/techinvestor/lamonica/
http://www.mail-archive.com/report-text@skyreport.com/msg00119.html
Revenue: Dish Network vs. Sirius
A revenue comparison between satellite television and satellite radio should also be mentioned.
A revenue comparison between Dish Networks and Sirius again indicates some problems in the
dramatically lower ARPU for Sirius. In 1997, Dish had just over 1 million subscribers, a figure
Sirius is hoping to achieve this year. Yet, for the same 1 million subscribers, Dish had nearly
$500 million in revenue, while Sirius will be pushing for $200 million. One explanation for
some of the difference is that satellite television is purchased for the household, so a family will
only need one subscription. For satellite radio, a family might purchase several subscriptions.
Still, family subscriptions are discounted ($6.99 each) and will not reach anywhere near the
$50+ ARPU achieved per family in satellite television. In reality, in terms of revenue, the
Page 19
satellite radio market is simply not as large as satellite radio. Comparing the two industries can
be dangerous, if not appropriately weighted.
Growth Rates: Dish Network vs. Sirius
Perhaps one of the few bright spots in the comparison between Dish and Sirius is the growth
rate. In 1996, Dish had 350,000 subscribers, climbing to just over 1 million a year later. XM
had nearly 350,000 subscribers in 2002, but climbed to nearly 1,360 by the end of 2003. Sirius
too, is aiming for 1 million subscribers in 2004 after achieving about 260,000 in 2003. This can
mean one of a few things:
•
•
•
•
Satellite radio is simply catching on faster
People like satellite radio more
Hey, if it comes free in your car, why not?
Satellite radio is cheaper, therefore, more people can afford it
One satellite television is needed per household, while a family can have several satellite
radio subscriptions
We feel that it is a combination of each of these factors. Again, as light vehicles are coming with
the satellite radio pre-installed with at least 3 free months, it’s hard to say no until the free
subscription period ends.
One large benefit of the final bullet is that it indicates that the total market of subscribers is
larger than the total number of satellite TV subscribers. However, the largest problem is that
satellite radio already offers significant discounts for family subscriptions as previously noted.
Potential Risks
Many of the risks for Sirius are essentially the same as for XM Radio. Most of the primary issues
have already been discussed in the industry analysis, but, we’d like to take this space to discuss
several of the issues that we see as the most significant and also develop those that pertain
specifically to Sirius.
A third competitor? A fourth?! It may seem ridiculous that a third competitor will enter
satellite radio. However, in the future, this is a very real possibility. If Sirius and XM are able to
demonstrate meaningful profitability (which we feel is highly likely), the FCC is more than likely
to issue additional spectrum licenses. It should be noted that this has not been accounted for in
the model as timing, the number of licenses, and industry structure and profitability will be far
different in the future. However, it is a risk that we would categorize at least 50% over the next
10 years.
How likely will the FCC be to issue an additional license? The FCC has long been a promoter of
competition. In fact, on their website, the FCC states, “The FCC's strategic goal for competition
is to support the Nation’s economy by ensuring that there is a comprehensive and sound
competitive framework for communications services. Such a framework should foster
innovation and offer consumers meaningful choice in services. Such a pro-competitive
framework should be promoted domestically and overseas. 26”
26
http://www.fcc.gov/competition/
Page 20
Currently, the FCC is closely monitoring the competition between satellite TV and cable TV.
Cable television has been granted a number of licenses to compete with traditional cable
networks. In January, the FCC publicly restated their goals of satellite television, “"The vast
majority of Americans enjoy more choice, more programming and more services than any time
in history," the FCC said.”27
Moving into satellite radio is also likely to become cheaper as fixed costs decline. Satellite
technology, like nearly every electronic device, has been improving rapidly and prices have been
declining. Once the market for satellite radio is established, the reduction of fixed costs will
make it easier for new entrants to afford and justify entry for bids on the spectrum.
The masterBeta risk! All joking aside, Beta should again be noted for Sirius. As of February
21st, Sirius had a beta of 3.98228. With a beta of nearly 4, investors should mentally relate their
opinions of the future of the equity market over the next 12 months partially to their value of the
Sirius equity. Our intent is not to establish a formal opinion on the future of the equity markets
over the next 12 months, but rather, to demonstrate that the risk exists to a much larger degree
than normal.
As the satellite radio providers expand to lower income consumers, OEM trial
customer renewal rates could drop significantly. Currently both XM and Sirius are
experiencing OEM trial customer renewal rates in the range of 65-80%. We believe that this is
because the market is still young, and as they penetrate further “down” market, these renewal
rates will drop significantly. Given that most analysts do not anticipate a large drop in these
rates over time, we feel that overly optimistic long term growth prospects are built into the share
price.
As discussed in the industry report, local content remains both an upside and downside risk.
Currently the FCC prohibits XM and Sirius from offering local content, but XM has
attempted to get around this by creating one station for each locale. We do not know how the
FCC will react to this move. It is possible that they will forbid XM from offering this local
content, or they could also decide to open up the market by granting local radio licenses.
Obviously there is a possibility that the satellite providers will not be allowed to offer any local
content, and if that is the case it will offset the efforts from both XM and Sirius mentioned in
this report.
Sirius has significant execution risk related to chipset manufacturing. Sirius had to
delay the launch of their service by 12 months due to the failure of its chipset manufacturer to
deliver as promised. It must work out their issues by the start of next year’s NFL season (when
we anticipate a big marketing push), or it could become a major stumbling block in their ability
to recapture market share.
Potential Upside
International expansion offers uncharted and unvalued territory for upside in the long-term
that has not been modeled into street estimates. In November of 2003, Hugh Panero, the CEO
of XM stated that they had made initial steps and filings that would begin the process of
applying for distribution into Canada. Mexico has also been mentioned as a location of possible
expansion in the future. Canada, in particular, isn’t really large enough to support satellite radio
27
28
http://edition.cnn.com/2004/TECH/ptech/01/29/cable.competition.ap/
http://finance.yahoo.com/q/ks?s=SIRI
Page 21
by itself, something that is true for many countries29. However, international expansion also
has substantial regulatory hurdles that will take several years to unravel in either direction.
Although international expansion has been overlooked by street estimates, the roads through
the international gates are quite long. It will take some years for any international expansion to
come to fruition, if it happens at all. As a result, both XM and Sirius have continued their focus
domestically. Mr. Panero (of XM) stated, “What I have learned over time is that we really have
to stick to our knitting. While I am really excited about hitting a million subscribers, what we
really need to do is make the business work in the United States before we get distracted with
exotic things in Thailand. So I would rather focus my attention here.”30
Finally, XM has a lead in this space, at least in terms of publicly available information. But,
some of this process is unlikely to be widely known until the process is further along. At this
time, it is nearly impossible to add in this caveat as a reasonable line of value. But, the market is
so substantial that it offers the one true upside to Sirius radio valuation.
Aftermarket sales, especially through Radio Shack, present a potential additioan
revenue stream for Sirius. As relationships with automotive manufacturers’ progress and
this technology becomes more standardized, the aftermarket will become less important. Today,
however, it is the primary distribution channel. Both XM and Sirius sell through Best Buy,
Circuit City, and Crutchfield. XM has a relationship with Wal*Mart, but we do not view this as a
unique advantage as the average Wal*Mart does not fit the income profile of a satellite radio
customer. In addition, selling this product requires a salesperson to dedicate time to explain it
clearly to a customer (which means they have to understand it), and this experience is not
mirrored at Wal*Mart. Compared to the service and product explanation one would receive at
Circuit City or Best Buy, there is no comparison. Sirius recently completed a deal with Radio
Shack whereby they will be the exclusive satellite radio brand carried in Radio Shack’s 7000
stores across the country.31 We view this deal positively, because Radio Shack’s customers fit the
income profile of a satellite radio subscriber, and its sales associates are usually well prepared at
informing would-be consumers about new technologies. We think this deal gives Sirius a clear
edge in the aftermarket retail distribution area.
Sirius has recently made a number of other announcements regarding new
markets and distribution channels. In fact, they have a special VP dedicated solely to nonautomotive OEM and Specialty Markets. With XM laser focused on the automotive market,
these new channels present a unique opportunity for Sirius to gain additional share in a noncompetitive environment. While we do feel that if Sirius can execute on just one or two of these
programs (and that is a BIG if) it will have a material impact on market share, there is no
quantifiable data to support this, and as such we did not include it in our market share
projections. However these potential upsides were included in the sensitivity analysis,
specifically in the scenario with $4B in 2014 revenues. This was done to provide an upperbound
on the share price.
Rental Cars: Sirius has an exclusive deal with Hertz to offer its service to hertz rental
customers for an additional cost of $3/ day. As of 12/2/03 29 vehicle models at 53 Hertz major
airport locations nationwide were equipped with Sirius.32 In FY 2003 Hertz represented about
29
http://www.fool.com/specials/2003/03112000ceo.htm?source=EDSP
http://www.fool.com/specials/2003/03112000ceo.htm?source=EDSP
31
337
32
375
30
Page 22
9% of Sirius’ annual revenue, and WR Hambrecht projects it will be 4% in FY 04 and 05.33 XM
has a deal with Avis, but has not had a material effect on revenues to date.
Automotive Dealership Chains: Sirius recently announced a deal with United Auto Group
that includes joint marketing and promotion, and an agreement where vehicles ordered by
UnitedAuto’s 138 franchises across the United States will come with factory-installed, preactivated Sirius radios, where available.34 This could prove to be an effective technique for
Sirius to have its radios installed in automobiles that it does not have exclusive relationships
with. Currently XM has no announced deal with any dealership chains.
Truck/Trailer Rental Chains: Sirius recently announced a deal with Penske trucks to
promote Sirius satellite radios in cars sold or leased by Penskye dealerships. Penske will order
its new cars with factory-installed Sirius satellite radios where available, pre-activated with 16
streams of programming for a three-month complimentary period.35 Currently, XM has no
announced deal with any truck or trailer rental agencies.
Satellite TV: As mentioned earlier Sirius struck a joint marketing agreement with the Dish
network. Both companies will fund joint advertising and promotional campaigns, and Sirirus
will be the exclusive music provider for the Dish’s 9 million customers. This will be a unique
way for Sirius to reach new customers without them having to buy a car or hardware at a retail
outlet. Currently, XM has no announced deal with any Satellite TV provider.
Boats: Sirius has developed partnerships with a number of boat manufacturers, and has more
than 100 models of boats and yachts equipped with its service. At the recent Miami
international boat show Siriys equipped brands included odels of Four Winns, Carver, Formula,
Larson, Glastron, Wellcraft, Hydra-Sports, Aquasport, Triumph, Windsorcraft, Regal Boats,
Century, Cobia, Pursuit, and others.36 Currently XM has no partnerships with boat
manufacturers.
RVs and Motor Homes: In August 2003 Sirius struck a partnership with RiverPark, Inc., a
leading supplier of OEM equipment and exclusive distributor of Visteon products to the
motorhome market. The deal calls for Sirius to be offered as a factory installed feature with 1
year free subscription on 2004 models including the best selling Winnebago Ultimate Freedom
and at least four other brands.37 While this is a niche market with less attractive income levels,
these consumers would have more of a need for satellite radio than typical auto buyers.
Currently XM has announced no partnerships in this market.
Home Users: Sirius is making a strong push into both the home and office environment. They
have partnered with Niles, the leading provider of custom audio and video systems for the home,
to include Sirius as a standard feature in the next generation systems due out in Q2 2004.38
33
WR Hambrecht, “SIRI Q4:03 Below estimates, Subscriber Outlook Intact,” 1/30/04
579
35
573
36
555
37
005
38
049
34
Page 23
Sirius also partnered with Crestron, the leading manufacturer of advanced control technology
for custom homes, to include its service in all custom home electronic systems designed by
Crestron.39 Both Niles and Crestron sell to high end consumers that are much more likely to pay
for satellite radio. Currently XM has no partnerships in this market.
Commercial Businesses: There is a huge market for selling music systems to commercial
businesses such as restaurants, bars, and retail stores. It is currently dominated by two
companies, Muzak with a 60% market share (350K customers), and DMX music with a 10%
share (60K customers).40 The market is estimated at $500 million per year, representing about
560K businesses. 41 In addition, some industry sales people believe that the addressable market
is actually 2 million commercial businesses, meaning only 25% of the addressable market has
been penetrated in the 20+ years that this has been a competitive market.42 That means that
companies are not competing head to head; rather they are trying to convert people that
currently have no service. DMX charges around $45/month for its service, plus another $20-25
for equipment rental. Muzac prices are even higher, and both companies require you to sign a 5
year commitment.43 Sirius has recently started a commercial sales division to target the lower
end customers in this market. Sirius cannot offer the same level of service as DMX or Muzak,
for example continuous play without the “you are listening to Sirius” message. However their
service is priced at $24.95 for businesses (the higher price is due to increased copyright royalties
for commercial play), which is more than a more than 100% discount to DMX or Muzak. The
DMX sales executive we spoke to said he felt their was a significant opportunity for satellite
radio to penetrate lower end accounts that don’t want to spend the money or make a long time
commitment, and can tolerate the “station identifiers” and other reduced service levels.44 In
addition, this would allow Sirius to enter the market with advertising and indirect sales,
avoiding the direct sales force which is one of the major reasons for the high cost of Muzak and
DMX. Currently XM has not begun advertising to businesses, but they are planning to attend a
first trade show in March.45
Sensitivity Analysis
39
110
40
“Tuning In To Music That People Turn Out,” by Barnaby Feder, New York Times, 2/16/04, P C3 and
Conversation with Steven Padersky, sales executive, DMX Music
41
Tuning In To Music That People Turn Out,” by Barnaby Feder, New York Times, 2/16/04, P C3
42
43
Ibid.
44
45
Tuning In To Music That People Turn Out,” by Barnaby Feder, New York Times, 2/16/04, P C3
Page 24
Additional Sensitivity Analysis
In our analysis, we found that Sirius would have revenue of just under $2 billion by 2014. At
this level, the stock is overvalued today. However, analysis from a different perspective is useful
in this situation as the industry and firm are so new. In the sensitivity analysis included on the
following page, we show 4 levels of revenue by 2014. At the high end, we have $4 billion, over
double our current estimates. At this level, if we assume that they reach net margins of 14% (for
reference, Coke has margins of 15.5% on $20 billion in revenue46). SEE NOTE
At these levels of margins (and $4 billion in revenue), we assumed that Sirius would trade at
both 15 and 20 times earnings in 2014. Even at 20 times 2014 earnings in today’s present value,
this stock is worth only $3.25. Clearly, this company will need to find substantial additional
revenue streams and exceptional margins in order to approach this level. We do not consider
this realistic today.
NOTE: Coke was used for reference for net margins since they exist in an industry dominated
by only 2 players and have a number of other comparable characteristics to what the satellite
radio market will look like by 2014 in terms of their firm structure. Coke also has some of the
higher levels of net margins of public companies.
46
http://finance.yahoo.com/q/is?s=KO&annual
Page 25
Page 26
Important Disclaimer
Please read this document before reading this report.
This report has been written by MBA students at Yale's School of Management in partial
fulfillment of their course requirements. The report is a student and not a professional report. It
is intended solely to serve as an example of student work at Yale’s School of Management. It is
not intended as investment advice. It is based on publicly available information and may not be
complete analyses of all relevant data.
If you use this report for any purpose, you do so at your own risk. YALE UNIVERSITY,
YALE SCHOOL OF MANAGEMENT, AND YALE UNIVERSITY’S OFFICERS,
FELLOWS, FACULTY, STAFF, AND STUDENTS MAKE NO REPRESENTATIONS
OR WARRANTIES, EXPRESS OR IMPLIED, ABOUT THE ACCURACY OR
SUITABILITY FOR ANY USE OF THESE REPORTS, AND EXPRESSLY DISCLAIM
RESPONSIBIITY FOR ANY LOSS OR DAMAGE, DIRECT OR INDIRECT, CAUSED
BY USE OF OR RELIANCE ON THESE REPORTS.
Page 27

Yale SCHOOL of MANAGEMENT - Analyst Reports

Transcription

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