By Dustin Hermes

With the release of the Sirius XM iPhone application imminent and the Toyota Motor Sales agreement released it is important for investors to think forward on the changing dynamics of the company. In order to do so we must first take a hard look at the current state of the company.

Sirius XM has significant debt that is coming due. In ’09 and ’10 Sirius XM has debt payments of $339 and $180 million that the company states they have a firm payment plan for. Starting in 2011, ’12, ’13, and ’14 the company has debt obligations of $632, $485, $1,279, and $555 million, respectfully. Currently the company has issued no information on how they plan to pay for or refinance these maturities.

CEO Mel Karmazin has stated that Sirius XM has shifted its priorities from subscriber acquisition at any cost to becoming free cash flow (FCF) positive. The plan, according to Karmazin, is to increase revenues from current subscribers along with becoming more efficient on how the company invests in new subscribers.

Sirius XM has already begun increasing revenues on current subscribers in several ways. The “best of” packages currently reach 748k subs. The company also increased the price of the family plan by $2 and recently began charging $3 for internet stream. Sirius XM also plans to charge a $2 increase on monthly subscriptions for royalty fees the company must pay to the music labels.

So how does the iPhone application (and other soon to be released Smart Phone applications the company noted at its annual stockholder meeting) gain additional revenues from subscribers? Any subscriber that owns an iPhone, or any Smart Phone, will be far more inclined to pay the additional $3 internet streaming charge for the portable music application. Think of the possibilities one will have if they can listen to Sirius XM anywhere they receive phone service. On top of that, new subscribers will be more apt to subscribe to the company, at no cost to Sirius XM, because they will not have to purchase a receiver on top of their subscription price. The cost of the phone is likely to be considered a sunk cost by any potential subscriber and therefore not considered when weighing the option to purchase a subscription.

Now let’s take a look at the deal Sirius XM announced with Toyota Motor Sales regarding OEM’s. The company recently reported that subscriber acquisition costs (SAC) have been cut from $91 to $53 in the first quarter of 2009 year over year. How has the company achieved this? Part of the way the company has decreased its SAC is by focusing spending on OEM’s with a high conversion rate from the promotional sales period when a new car buyer purchase a car to becoming a self-paying subscriber. Sirius XM has isolated OEM conversion rates into two categories; those that have a high rate of conversion (70%) and those that have a low rate of conversion (30%). It currently takes 12 months for the company to recoup its SAC on the high conversion rate OEM’s and 29 months on OEM’s with the low conversion rate.

Sirius XM’s agreement with Toyota Motors Sales focuses directly on high conversion rate vehicles. XM radio will now be a standard installation on all 2010 Camry vehicles with premium audio and be an optional upgrade for Camry’s with standard audio. So what does this mean? Sirius XM has seen the conversion rate from promotional subs to self-paying subs is higher when the purchaser of a new vehicle forks out the extra money for premium audio. This makes sense as Sirius XM has noted the correlation between high quality audio in a vehicle and their product. Sirius XM saves money by not wasting installations that have a higher probability of never becoming a self-paying subscriber. It also gives the purchaser of a Camry with standard audio the option to have XM installed, meaning, the new car buyer knows they want satellite service and therefore are more likely to become a self-paying subscriber.

In the end, as Karmazin has stated, subscriber growth will be negatively affected based on less OEM installations. Don’t let the subscriber numbers fool you. A lower OEM installation rate with a higher promotional period conversion rate will save Sirius XM money and allow the company to recoup SAC at a much faster rate. This, in turn, will drive the company to becoming FCF positive.

Sirius XM’s new focus on increasing revenues from existing subscribers and efficiently acquiring new subscribers is exactly what the company needs to become FCF positive and begin addressing the debt that will be maturing shortly.

Position: Long SIRI

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