Why Merrill Lynch Sees Sirius XM Worth $5 per Share After Earnings

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Sirius XM Radio Inc. (NASDAQ: SIRI) manages to keep growing and growing. The strong U.S. auto market is making it grow even faster than some of the biggest bulls might have once guessed. Bank of America Merrill Lynch has reiterated its Buy rating on Sirius XM, and the firm sees the stock valued at $5.00. If the firm is correct, Sirius XM shares have about 35% upside.

Merrill Lynch’s Jessica Reif Cohen thinks that Sirius XM essentially filled in the detail on a solid fourth quarter and a very strong 2015. Interestingly enough, the name Howard Stern was not mentioned once in this research report.

Sirius XM reported fourth-quarter consolidated revenue of $1.2 billion (up 10% from a year earlier), above the firm’s $1.19 billion estimate. Quarterly net additions were 634,000 (with 472,000 being self-paid). Self-pay churn was 1.9%, versus the firm’s same 1.9% projection. The company reported adjusted earnings per share (EPS) of $0.03.

Adjusted EBITDA grew 4% from a year ago to $396 million, a tad under the Merrill Lynch expectation of $414 million. The firm believes that the lower than estimated adjusted EBITDA result was driven by higher subscriber acquisition costs and significantly higher general and administrative costs than it had expected. Still, the fourth-quarter result drove adjusted EBITDA for 2015 to $1.66 billion.

Free cash flow declined by 9.5% to $299 million, but free cash flow per share fell by 3%. Sirius XM repurchased $369 million in stock during the quarter, shy of the $475 million that Merrill Lynch expected, as the strong price performance in the fourth quarter kept management from buying back too much stock. Conversely, when the share price fell along with the broader markets, Sirius XM increased the pace of share buybacks in January and repurchased nearly $200 worth of its stock. The company has approximately $1.4 billion remaining under its share buyback plan.

Reif Cohen’s commentary said:

We believe the company remains positioned to drive significant future capital returns, considering leverage of 3.3x (versus 4x target). Other metrics similarly healthy operating results were strong across the board. Churn of 1.9% remained in line with the prior period, while average revenue per user, at $12.75 (up 2%), beat our projection of $12.61. Advertising revenue continued to show strength – rising +20% (versus our 20% estimate) in the quarter. The new vehicle conversion rate slightly declined to 39% (versus our 41% estimate and 40% in the fourth quarter of 2014), while the used car conversion likely also remained in the low to mid-30% range, given the very strong subscriber results.

Merrill Lynch says that Sirius XM is a core pay-entertainment holding for investors. The firm gave seven points on this matter:

  • fast growth, including a 3-year (2014-2017E) revenue CAGR of 8%, an EBITDA CAGR of 11% and a FCF/share CAGR of 20%;
  • 70+% contribution margin;
  • sizable capital return capacity;
  • ~80% EBITDA/FCF conversion;
  • strong SAAR, with rising new car penetration;
  • vast potential growth in the used car channel;
  • and connected vehicle opportunities.

Reif Cohen’s $5.00 price objective is based on a discounted cash flow (DCF) valuation, strong revenue expectations, and growth of EBITDA and free cash flows. The DCF is based on a weighted-average cost of capital of approximately 8% and perpetual growth of 3.0%.

Merrill Lynch did offer up some risks to its big upside call here:

  • Competition
  • Macro environment
  • Auto sales
  • Unknown total pay-adoption rates

Sirius XM shares were last seen down 2.45 at $3.63, which would imply upside north of 35% to the $5.00 price objective from Merrill Lynch. The consensus analyst price target is $4.69, and the 52-week range is $3.31 to $4.20. The highest analyst price target remains up at $5.25 by the firm Pivotal Research. The lowest analyst price target is $4.00, still close to 10% above the current share price.