Asking Sirius Questions

You would be hard-pressed to find a better stock market performer over the last two years than Sirius/XM (SIRI). A $10,000 investment in SIRI two years ago amounts to $129,283, as of Friday's close. The same investment in the Nasdaq 100 (QQQQ) would have yielded a relative pittance of $21,489. SIRI also blows away returns on $10,000 stakes in notable Nasdaq high-fliers, including America's Company (AAPL) ($39,486), Netflix (NFLX) ($55,880), Chipotle (CMG) ($50,248), and Priceline.com (PCLN) ($56,549). Impressive, but can the meteoric rise continue?

Before buying in at or around SIRI's 52-week high, investors should seriously consider the risks that could exert pressure on the stock. You can begin evaluating risk by reviewing a company's own words in its annual report (Form 10-K) filed with the SEC. Sirius/XM filed its report last month in conjunction with its most recent earnings report. The two key risk factors Sirius/XM lists involve competition, which I address elsewhere, and its tight link to the fortunes of the automobile industry.

Risky Business

"Our business depends in large part upon automakers and demand for our service is difficult to predict."

Sirius/XM notes that "Most of our new subscription growth has come from purchasers and lessees of new and used automobiles..." The 10-K points out that several factors could have a detrimental impact on automobile production and sales, "including the availability of consumer credit, general economic conditions, consumer confidence and fuel costs." What the report does not mention, however, is that rising fuel costs could negatively affect credit flow, the economy, and the consumer's inclination to spend.

Oil's recent spike above $100 on unrest in the Middle East might not last, but one thing is virtually certain -- prices will remain volatile. And $100 crude remains much more likely than what we saw during the now distant era of cheap oil. Even if rising fuel costs do not cut into car sales, they could drain new and used car buyers' appetite for extras. Buying a new car, knowing full well that you'll be paying more to fill up the gas tank, could prompt you to say no to everything from chick magnets like spoilers and sunroofs to a satellite radio subscription after your trial, assuming you use it, runs out.

In 2010, Sirius/XM converted a more-than-formidable 46.2% of car buyers and lessees who received a trial subscription into self-pay customers. Looking at year-over-year numbers, it's quite clear that a large part of Sirius/XM lives and dies by the fortunes of the automobile industry. In 2010, the company added 982,867 self-pay customers versus just 154,275 in 2009. Early 2011 auto sales continue to experience an impressive run. Thanks to this, Sirius/XM's 2011 conversion figures might be as strong, if not stronger than 2010, but, in an environment of volatile and steadily rising fuel costs, a business so dependent upon motor vehicle sales should give investors a pause.

Increased Subscription Fees

Interestingly, Sirius/XM does not mention an inevitable event as a risk factor in its 10-K. CEO Mel Karmazin did address the prospects of an increase in the monthly cost of a Sirius/XM base subscription during the Q&A portion of the company's conference call:

Certainly, we believe that our original price point of $12.95 when we started was attractive. We priced it that way because we wanted to grow our subscribers as rapidly as we could. We believe that we would get more subscribers at $12.95 than we would at $16.95 or at a higher price. So that was the determination then. Since the price was put in 2002, we added a great deal of content. Howard Stern was added, the NFL was added, we added NASCAR. So we believe that we offer great value to our subscribers. We are constantly looking at ways of continuing our growth and not pricing ourselves at a point that would really hamper our growth. But I think like all businesses, you should assume that the company is going to increase prices in the future. You just need to do that to remain profitable and to continue to invest in content. We have not certainly announced anything at this point in the way of increased prices. But the reality of it is, is that it's something that you should expect will happen in the future (Emphasis added).

While the FCC allowed Sirius/XM to charge customers a music royalty surcharge of $1.98, beginning in the summer of 2009, the company cannot raise its monthly subscription fee until August 2011. If Sirius/XM chooses to raise its base rate from $12.95 to, say, $16.95, as has been rumored, it could put a serious dent in its growth. A $4.00 increase would effectively bring the monthly fee to just under $19.

Sirius/XM faces a delicate situation when it decides to hike its rate. A $4.00 increase all at once would likely trigger a significant outcry. The company could choose to implement increases little by little over time, but this approach could fuel a perception that the Sirius/XM fees go up every time you turn around. In any case, it's a safe bet that the company will take advantage of its future ability to charge more -- Karmazin stated it plainly. It's anybody's guess what impact it will have. SIRI devotees will claim that commercial-free, top-notch content is worth any price of admission, but the subsequent impact on less ardent subscribers and prospects remains unknown. At the end of the day, it's an uncertainty, and investors tend not to like uncertainty for good reason.

Conclusion

I am long SIRI via Jan 2013 $3.00 call options. I anticipate near-term appreciation in the shares to above $2.00. As I noted in another Seeking Alpha article, I intend to sell my option contracts when-- and if-- this uptick in the underlying stock occurs. At that juncture, I will likely look for technical signals that SIRI stock is overbought. If unfavorable conditions exist -- high and volatile oil prices, a leveling off of auto sales, and/or more insight into Sirius/XM's price increase plans and the potential impact on growth and churn -- I will consider going short SIRI via the stock or by selling call options.


Disclosure: I am long SIRI, AAPL.