Let's Get Sirius: Howard's Da Bomb, But...

Overview

Sirius has always been a complicated company with a complicated story. First of all, you've got the blue-sky opportunity of satellite radio, which has lured in many only to see them washed away in a sea of red ink and missed expectations. Then you've got the deal with Howard Stern, a mythic figure with the cult status of Steve Jobs and whose importance to the well-being of the Company (and its stock price) is a topic of endless conversation. Next you've got Mel Karmazin, yet another big personality in a small company with an agenda all his own. And finally you've got the technical issues of getting good information on Sirius that is not simply a parroting of mainstream media - because Sirius is not only a star and it's not only the name of a key character in the Harry Potter series (Sirius Black), it is an element of a wide variety of other notable search terms. This is when powerful investment-oriented vertical search tools come in handy.

Bottom line: all the chatter about Howard's big deal at Sirius ($100 million+ per year plus the $225 million of stock) is really not the point. The Sirius business model contains a massive amount of leverage that represents a virtuous cycle between subscriber growth and ad rates, and Howard is the engine to help the Company reach its inflection point and to begin generating gobs of cash. A few notable problems exist, however:

1. Like Apple, a Sirius investor is implicitly short a "Howard Put Option" (see my earlier post on the Jobs Put Option) as the diversification Mel loves to talk about ("Howard - we can live without Howard") appears largely illusory; and


2. The Company's revenue recognition, that shows 100% of ad revenues on its top line (nowithstanding the fact that a chunk of these revenues are contractually owed to our friend Howard, but how much we don't really know), kind of clouds the true revenue picture for a company whose loss-making ways will cause revenues to be the primary valuation metric for the forseeable future.

Howard is cool. The model is powerful and the trends are favorable. He has and will continue to generate a ton of value for Sirius. But this is a complicated stock not for the faint-at-heart. Eyes wide open, friends.

Howard: A Cult Hero With a Cult Following

An early look into the potential ramifications of Howard leaving Infinity from audiovideo REVOLUTION:

********************

All of these FCC threats mean nothing to outspoken Howard Stern who now literally begs to be fired released from his contract on his show. He threatens that he will take his estimated 18,000,000 listeners to satellite radio and kiss Viacom goodbye. Stern’s importance is two fold for Viacom. He not only generates incredible revenue in syndication to clients like Clear Channel – he also serves as the main draw for Viacom’s vast network of male oriented, FM talk radio stations across the country. One would think they would do anything to save the “King of all Media” but that might not be the case.

Despite Stern’s power, it is not inconceivable to see him cut loose by Karmazin assuming Viacom started losing stations. In the event Stern was let go, the ramifications would be earth shattering. If Stern ended up on satellite radio he could change that media forever much like he defined the male demographic on terrestrial radio. Currently, satellite radio has about 1.3 million total subscribers with a little over 1,000,000 on XM and about 250,000 on competing Sirius. Even a tiny fraction of Stern’s 18,000,000 listeners could take a second place player like Sirius and turn them into the leader in satellite radio literally overnight. More importantly, with satellite radio’s subscription model each new listener equals profitability.

********************

I think this is useful for framing Howard's impact beyond his own shows: he drives traffic to related properties, expanding the value of the whole. This on top of his massive legacy audience, a portion of which was able to bring over to the subscription-based Sirius.

Going into the deal it is easy to see how Joe Clayton, CEO of Sirius, had imbibed the Kool-Aid as well. From the Sirius/Howard Stern press release:

SIRIUS estimates that Stern only would need to generate approximately 1 million subscribers in order to cover the costs of the deal. Total production and operating costs for the Stern show, including compensation of the show cast and staff, overhead, construction costs for a dedicated studio, and a budget for the development of additional programming and marketing concepts, is estimated to be approximately $100 million per year.

"When you look at his enormous existing fan base, all we need is for Howard to bring in a small fraction of his weekly audience for this agreement to pay for itself," said Clayton. "Anyone who knows Howard, and who understands how loyal his fan base is, will not have a hard time seeing the incredible potential for growth that he will represent for SIRIUS. We are absolutely delighted that he will be joining our company, and we look forward to expanding the scope and diversity of SIRIUS programming with him."

So back then the bar was set at $100 million. To Sirius-watchers this represented the annual break-even incremental revenues required from Howard's presence on their airwaves. And this doesn't take into account the initial stock payment or the additional subscriber-based stock payment (which was received by Howard based upon achievement of targets). To some this represented one of the most egregious examples of payment-for-talent-gone-wild, with little hope of an economic return for shareholders. After checking out the Internet and doing a little analysis, I'm not so sure. Let's take a closer look at what this deal really meant and potentially means today.

Howard: By the Numbers

Based upon what we know, Sirius and the analyst and investment communities might have viewed the Howard Opportunity like this back in October 2004:

Howard's Infinity audience:                             18 million

Approximate cost of annual subscription:       $120 / year

Total revenues:                                                $2.16 billion/year

And these numbers don't reflect potential ad revenues, just subs. Not bad. Lots and lots of upside. Especially when the break-even sub-level is only 1 million, roughly 5-6% of his audience at Infinity, with the ad revenues as gravy on top. Fast forward to today. Analysts are expecting Sirius 2006 revenues of approximately $615 million on about 6 million subs (up from 3 million prior to Howard's joining). Similar to the simple-headed but somewhat effective method I used when justifying Google's purchase of YouTube on a valuation basis, I will seek to bring some back-of-the-envelope intuition to the potential for Sirius' ad revenues.

2 channels x 24 hrs/day = 48 hrs of programming/day
x 3 ad minutes/programming hour = 144 ad minutes/day
x 200 broadcast days/year = 28,800 ad minutes/year
x $5000-$10,000/ad minute = $144-$288 million ad revenue/year

Wow. Is this possible? Haircut these numbers by 50% and it still looks like Howard has the potential to cover his basic $100 million nut based upon ad revenues alone. Add in the value attributable to those incremental subscribers (3 million x $120/year = $360 million) and Mr. Clayton's pie-in-the-sky deal doesn't look so crazy after all. Further, it appears that Howard's Sirius' ad revenue numbers could eventually eclipse those from his Infinity days. From CNN/Money 07/18/2005:

********************

Stern's show has been a huge source of revenues for Infinity -- attracting, some analysts say, $175 million a year in advertising. Of that, Stern and his sidekicks pocket at least $30 million, according to these estimates.

********************

Well, now Howard is making a few more bucks at Sirius than he was at Infinity, but it is pretty amazing to consider the revenue impact he could have due to both ad revenues and subscriber growth - possibly well in excess of $500 million per year at current subscriber levels. When you capitalize this at a multiple reflective of Sirius' rapid growth, this has a value impact in the billions of dollars. Not too shabby.

Howard: The Greatest Show on Earth?

Call him what you will, a lightning-rod, Mr. Headline, whatever. Bottom line, he is definitely one of those guys for whom "All PR is good PR." Everything he says or does just stirs the pot. What Howard earns is always a subject of spirited conversation - from Orbitcast 02/08/2007:

So says Forbes in their The Best-Paid Talking Heads feature. The $302 million payout for Stern of course includes stock, bonuses, and salary all lumped together in a big ball of cash.

********************

24/7 Wall St. is quick to suggest that Stern's pay may not be worthwhile since Sirius earned $167 million in revenue last quarter, has an operating loss of $154 million and is still walking around with over $1 billion in debt. (Something tells me that 24/7 isn't very bullish on SIRI.)

There's no question in my mind that 2006 was a rocking year for Sirius, and Stern obviously deserves his due credit for contributing significantly to this feat. I'm just curious about the year ahead (and an earnings call might help).

Where there is Howard there is controversy and differences of opinion, as two of the commenters to the Orbitcast post so aptly displayed:

Sean, you are correct. Bridge and others estimate that HS MAY have brought in 2.0 million so I'm very soured on the Sirius logic, and Howard at the moment. It appears that he is not paying his way at all.

Better yet, ( or worse yet ) Howard is 53. What happens to Sirius in 2010 or sooner ( God forbid ) if Howard leaves SIRI or exits the world as Anna Smith just did in such an untimely fashion ? Isn't Sirius's name, face and reputation tied to Howard ?

Sirius would drop like a rock.

Here's what I think.

Howard gets the money when they ( subs ) come, and KEEPS the money when they ( subs ) go out....and Mel too is long gone. Stern was nothing more than a high priced bargaining chip for Mel to execute his merger-buyout hand.

Good for you Howard, but I think less of you for hosing us...even though Mel turned on the sprinkler.

Posted by: Pockpie Hates THIS War   | February  8, 2007 06:24 PM

********************

Let us not forget that there is advertising revenue on his show. It is not only the subscribers that pay his way. He has done more for this company than anything else. Look at the way things have turned. Sirius is now the number one selling satrad product in retail. Sirius is on par to beat XM by the middle of next year in sub numbers. All the Sirius haters have said everything Sirius has done has been bad, thing is everything they have done has been to take out the competition, and it is working.

I say pay the man, I don't listen to him, or even like him, but he is definately worth the cost

Posted by: jkdillard1  | February  8, 2007 07:35 PM

Regardless of one's view of Howard's financial impact, I think there is little question that he is the driver of subscriber growth at Sirius. From Brandon Starr's blog:

Why Sirius?

I really enjoy my Sirius Satellite Radio.

I have one I can remove from my car and put into a base in my house. Because my job requires me to be in my car, mostly alone, for five hours, I listen to it more in my car.

I also listen online--like right now.

Believe me when I say that when you have five hours a night to work in a car, you figure out pretty fast what's available to listen to on the radio. I immediately latched onto The Howard Stern Show. Some bits are hits and some are misses, but the main people on the show are all excellent storytellers. My favorite part of that show is when they spend an hour just chatting about what happened over the weekend or during last night's dinner.

Howard was the main reason I switched to Sirius.

********************

And then there is Mel. Mel has publicly said that Sirius is not reliant on Howard. Oh, ok Mel. Here is what he said at the Reuters Media Summit last December - from FMQB:

Though it is estimated that half of Sirius Satellite Radio's 6 million subscribers tune in to the Howard Stern channel, Sirius CEO Mel Karmazin says that the satcaster is not solely reliant on the King Of All Media. Asked at the Reuters Media Summit what would happen if Sirius lost Stern, Karmazin said the company has plenty of other programs, including a soon-to-be-launched 24-hour Catholic Church channel, a popular Martha Stewart show and plenty of sports, news and music programming.

"How are we reliant (on Stern)?" Karmazin said at the Summit in New York. "I don't think we're reliant in any shape or form. We have 135 channels." He continued, "There are a lot of people who like Howard and they tune in to Sirius... there are many, many people who don't like Howard and they never touch the Howard Stern channel."

Still, Karmazin conceded that demand for Stern does drive listeners to Sirius.  The company expects to generate $1 billion in revenue next year and have 6.3 million subscribers by the end of 2006.

********************

Huh? We're not reliant but demand for Howard does drive listeners to Sirius. Right, Mel. You sounded really convincing there for a nanosecond. Let's face it - you control a very valuable (and f*cking expensive) asset and you will use it in a way to enhance your (and Sirius shareholders') wealth. And that's the way it should be. But don't think you're snowing us. While Howard may not be Sirius, it is pretty hard to overstate his importance. And then there are those little merger rumors. From Newsday.com

Just about now, Howard Stern is marking his one-year anniversary with pay radio on the Sirius satellite network, and what signal seems most clear is that the Shock Jock won't be making noise for free over the air anytime soon.

Whatever visibility Stern has lost by changing his status from "free" to "pay," his 12-month run - with four more years to go on his contract - has helped to significantly improve the financial health of both Sirius and competitor XM as real options for drive-time and anytime radio listeners.

********************

While both companies' stock prices have been battered, the boost in listener awareness has fueled recent speculation that the services may merge, although Sirius chief executive Mel Karmazin was floating that rumor before Stern arrived at his company. Neither Sirius nor XM has yet admitted to actually sitting down for such discussions with the other.

********************

Whether they merge or not isn't my point. My point is that Howard is sickly important to Sirius and the satellite radio industry, and that he has unquestionably made his mark during his relative short tenure in the radio-for-pay medium.

What's the Frequency, Howard?

As ad revenues become increasingly important to the Sirius financial picture, there is a small matter of revenue recognition that I think warrants some attention. Now I think Howard is getting a piece of these revenues but how much is unclear. From the 09/30/2006 Sirius 10-Q (I have added highlights for emphasis):

We recognize revenues from the sale of advertising on our non-music channels as the advertising is broadcast. Agency fees are calculated based on a stated percentage applied to gross billing revenue for our advertising inventory and are reported as a reduction of advertising revenue. Advertising revenue includes advertising sold in exchange for goods or services (barter) recorded at fair value. Revenue from barter transactions is recognized when the advertising is broadcast and goods or services exchanged are received. Goods or services received are charged to expense when received and/or used. Barter transactions are not significant to our unaudited consolidated financial statements. We pay certain third parties a percentage of advertising revenue. Advertising revenue is recorded gross of such revenue share payments in accordance with EITF No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” as we are the primary obligor in the transaction. Advertising revenue share payments are recorded to programming and content expense during the period in which the advertising is broadcast.

So what this basically means is that the full amount of ad revenues shows up in revenues, notwithstanding the fact that a(n undetermined) chunk of these revenues are going to, well, I guess our friend Howard. My only point here is that as ad revenues grow and begin to have an increasing percentage share of overall revenues, one needs to be mindful of capitalizing revenues without taking into account the leakage of these revenue sharing arrangements. That's all.

Conclusion

Yes, Howard has a big deal. Yes, Sirius has been losing gobs of cash. Yes, the stock has reacted very poorly as of late. Yes, if Howard gets hit by a bus that would be really, really bad. But the tone and data out there on the Internet and in the offline world is pretty favorable. At this point Sirius has already done a lot of the heavy lifting - building out the technology platform, bringing a premier engine of revenue growth to leverage the platform, and setting the stage for not only the virtuous cycle of:

=> a rise in subscribers => drives ad rates higher => drives revenues up
=> which provides the fuel to go out and attract new subscribers....

but an increase in ARPU through additional content, i.e., video services. This is not a bad back-drop, even given the debt-laden capital structure with additional losses to come. And the key part of the puzzle is Howard. Love him, hate him, whatever. For the long-term prospects of Sirius, he's da bomb.

The author does not hold a position in this company's securities.

Comments

[howard lindzon]

i wish

[Yaser Anwar]

"Whew!, I thought this whole post was going to be about Howard Lindzon."

LOL, Shane, same here!

Haha, with the press WallStrip has been getting, I thought Roger was like "hey why not give credit where its due."

WallStrip/Lindzon on Sirius, now that is serious! lol

[Shane]

Whew!, I thought this whole post was going to be about Howard Lindzon.

[Yaser Anwar]

SIRI's weaknesses can be seen in multiple areas, most importantly weak operating cash flow and mediocre growth in its EPS, which has led to negative performance of the stock.

That being said, SIRI's management remains focused on growing the core subscriptions business and initiatives aimed at growing a dual advertising revenue stream, as Karmazin ramps up the ad sales force. With Stern and other popular channels for sports, news and talk programming, i.e. CNBC, NFL etc, I think advertising as a % of total revenues could approach 10% by the end of 07.

S&P believes that 07 will be a major staging year for the ramp up of automotive OEM factory-installed units (led by Chrysler and Ford). They assume a modestly higher ARPU, partly offset by increased family plan and multi-year discounts, they estimate that total revenues will approach $1 billion in 2007 vs. $600 million in 06.

Assuming 1.8% monthly churn, S&P analysts expect SIRI to add a net 3 million to reach nearly 9 million by the end of 2007.

Investing in SIRI presents a high risk situation thanks to negative cash flow and weak operating performance. That being said, I think the merger expectations will get more favorable and increase as time passes by, and as you mentioned the internet data presents a bullish scenario.