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A Fine Wine

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Sirius Satellite Radio (SIRI) a $20 stock?

Surely I must be crazy to think such thoughts but am I really nuts? No, I'm quite sane really and with a fairly simple road map I'll show you why I think SIRI is a bargain that over time will mature to be a very fine wine.

For those that have followed my work over the last five years, you know the basics. SIRI dominates the industry with a lock on premium content that it can sell to a very, very large audience without worrying about competition due to barriers to entry.

That last statement on barriers to entry by the way is the reason the proposed merger with XM Satellite Radio (XMSR) is taking so long for approval, but I digress.

With more than 8 million subscribers SIRI is barely tapping into a market that I estimate will reach in excess of 50 million. How do I get that number?

Very easily if you consider the number of vehicles in this country and the fact the majority of those have a radio inside. My research suggests a number that totals at least 250 million with approximately 16 million vehicles new sales added each year.

Given that pay radio's product is far superior to free radio, I am quite certain that over time the industry will meet and exceed my expectations for growth. The only real question is when?

Let's take SIRI independent of any merger. At 8 million subs, I assume growth slows to about 30% this year due to absolutely horrendous economic conditions. From there on I assume growth rebounds to 50%.

That means SIRI alone will reach 52 million subs by the end of 2012. Take those numbers assume a $12 sub rate, 20% profit margin, some sponsorship type ad revenues, and a price/earnings multiple of 15 and I get a valuation of $20 per share in 2012 (based on current number of shares outstanding).

I know that many believe that consumers won't pay for something they already get for free, but please are we not beyond that argument already? For crying out loud, SIRI alone is at 8 million subscribers and they were growing in excess of 100% before last year when growth slowed to 70%.

What about the absurd losses and the fact that SIRI has never made a dime? All true. The losses are absurd, but not for an emerging growth company with a market potential this large.

According to management SIRI has the capital to absorb continued losses until they reach profitability. Yes, it is taking a bit longer than expected, but the potential reward should take the sting off the wait.

I can appreciate the concerns over valuation and capitalization. What I don't accept is the premise that SIRI has a failed business model. It does not.

The problems facing the company today have much to do with the economy and the weakness thereof. Honestly if there was even an ounce of stability, SIRI would be doing much better from a growth perspective.

And it needs that growth to reach profitability. When it gets there, the market will eventually catch on.

The point I am trying to make is that there is more than enough evidence to convince me of the potential reward that taking the risk at these levels, valuation levels not price levels, makes Rational sense.

Now let's factor in the merger with XMSR. Do you have any idea how huge this will be for the company if approved?

Let's imagine for a bit what that world would be like. No more competition for talent and no more competition for subscribers. SIRI would be free to do what it does essentially unencumbered.

That fact alone is why the deal is taking so long to be approved. The beauty is that SIRI does have plenty of other competition to justify Justice eventually approving the deal. There is free radio for one and then other devices like I-pods that make this so.

Even if SIRI needs to further concede on some pricing issues, they should do whatever is necessary in order to gain approval. Once they have it, costs will drop significantly making it more likely that the combined entity will indeed reach profitability without further capital needs.

At the end of the day, I am still extremely bullish on SIRI. The fact that I have such a contrarian view of the story provides much comfort. $20 may take patience and time, but investors should be willing to wait.

Heck, if I am wrong and SIRI only hits $10, investors will still have a triple from these levels.

Now for some really good news. In addition to my role with www.investorplace.com and www.investorplaceblogs.com I am re-launching my highly rated newsletter The Rational Investor as a premium, on-line only service.

The site is currently under construction and should be ready to go shortly. If you would like to sign-up early, I'm offering a huge discount of 60% off the listed price of $250 per quarter.

Drop me a line at jdlugosch@hotmail.com to learn more.

Jamie Dlugosch
The Rational Investor