Every few generations our culture finds new ways to define itself. Usually there is no stronger indicator of culture’s shifting winds than the music a generation listens to. The method in which a generation listens to its music defines it as well. Is it possible we are in the midst of exactly that? Another media revolution of transformation in the winds, from terrestrial radio and television broadcasters to satellite media?

The current population wants access to information everywhere and on demand.  Generation “Unlimited” has no concept of limitation.  They live in a world where information of every type is available at the speed of an electron in more forms than they can count.  Information and how it is channeled to a user permeates every aspect of business.  AM and FM Radio don’t work everywhere geographically so it’s fading.  Same thing for television, initially change came in the form of cable and now with continuing dominance by satellite media.

How many people still remember the world of no television?  Black and White television broadcast?  The days when AM radio was the mainstay of the American living room?  In every single instance of such change, critics denied the very possibility it could happen.  Emotions have always  run especially deep in American society when it comes to our music and how we listen to it.

Evidence is mounting that we’re in the middle of such a cultural shift.  Investors who recognize such a change early on are usually uncommon.  There are several things to keep your eyes on right now.  First is Sirius XM Radio’s (NASDAQ:SIRI) recovery during a difficult economic period. Despite one of the longest mergers in corporate history between then Sirius Satellite Radio and XM Satellite Radio, Sirius XM Radio has emerged from 2009 as a remarkable story in underestimation.  On any given day diehard Sirius XM Radio fans and investors could rely on a myriad of articles decrying its existence.  Half a year after its merger was complete, media sources continued to publish content claiming it was destined for bankruptcy despite a clear end to those fears. If not fear of bankruptcy, readers would easily find articles claiming everything from failure of the company’s iPhone application to rumors of Howard Stern leaving the company.  All were obviously unfounded, but nevertheless the company emerged from 2009 going from a microscopic six cents (yes the number “6″ folks) way back in February 2009 to its recent peak of $1.18 in mid-February 2010.  Since then gains have retraced slightly below a dollar, closing yesterday around .953 with after hours movement to 97 cents.  Volume was a record-setting 609 MILLION shares as of today, April 7, 2010.

Now throw in a few other possibilities circulating the blog circles.  There are so many at this stage even loyal blog followers are having a difficult time tracking them. One prevailing theme reigns: John Malone’s Liberty Media is up to something.  Hints keep showing up each week. From his company’s efforts to delve into the recent Worldspace Satellite Radio bankruptcy proceedings to filings introducing the world to an entity known as “Liberty Satellite Radio,” and most recently signs Liberty might increase it’s ownership stake in Sirius XM Radio (which currently sits around 40%).

I would like to throw a theory to the four winds.

John Malone is undoubtedly one of the most successful corporate leaders to emerge post-crash. His maneuvers early in 2009 to provide assistance to Sirius XM Radio in sheer spite of efforts by Dish Network’s Charles Ergen to acquire the company shows the business leader’s mettle. Not only acquiring a 40% interest in a new media monopoly early in it’s fiscal recovery, but simultaneously thwarting Ergen’s bid at the Satellite Radio company’s assets and controlling his competition.

Consider what could come post-John Malone. There is no doubt Greg Maffei is a champion for the company, and Satellite Media as a whole. Add to this Sirius XM Radio CEO Mel Karmazin’s absolutely incredible survival ability, saving Sirius XM from an uncertain fate.

Why Liberty Media’s recent interest in the Worldspace assets?  Little did many people realize at the time, but XM Radio’s infrastructure – now part of Sirius XM Radio – is compatible with the Worldspace Inc technology. It took a while for our readers to pick up on the significance of that (but they rapidly learned from our own Steve Garcia, who has pretty much nailed this situation down from the beginning.)

Now bounce to another part of the drama.  John Malone stepping down from the DirecTV Board of Directors.  Could John Malone be ready to turn the reigns over to widely recognized successor Greg Maffei?  Think about this: if this occurs, would it not make perfect sense for Mel Karmazin, who steered Sirius XM through the 2009 minefield, to lead a combined global strategy headed by Liberty Media to push satellite radio content overseas?

There are more sides to the story than facets on a 100-carat diamond.  Any investor covering the satellite media companies will quickly declare something is going on.  As the plot thickens, readers continue to look for answers as it unfolds.

Who can blame them.  Many retail SIRI investors have already experienced gains other investors dreamed of during their entire investment experience.

Factor in more problems with terrestrial broadcasting companies keeping the lights on.

Stay tuned.

Disclosure – Long SIRI/No holding in Liberty Media

Sirius XM Radio(NASDAQ:SIRI) has received two S & P corporate credit ratings upgrades this year. In April S & P took their corporate credit rating  from CCC to CCC+, and another one in August to a B- rating.  Perception of a company’s debt load and its ability to repay that debt is vital to a company’s ability to obtain new money for refinancing existing debt for better terms, or to obtain new debt altogether.

Now this month JP Morgan (NYSE:JPM) has initiated coverage of  Sirius XM’s credit.  They have begun coverage with an over-weight rating.  Sirius XM Radio has confirmed this coverage.

This rating typically indicates the company’s debt is a reliable long term investment at this point in time.  As equities are bought and sold, so are a company’s bond issues.  It appears now that JP Morgan will cover both Sirius XM’s equity, which they have given a Neutral Rating, and now their debt as well.  JP Morgan re-initiated coverage of Sirius XM’s equity in May of 2009.

Being bullish on a company’s debt is encouraging, as the company may seek to further refinance existing debt, especially the 550 million in bonds sold in July of 2008, to facilitate the merger of the two companies, Sirius Satellite Radio, and XM Satellite Radio.  These bonds were considered “ugly financing” by investors due to the company giving lent shares along with the bonds so they could be properly hedged.  If this debt were to be refinanced with new money, the rate might come down (7%), and the lent shares (202 million against the current float) would be returned and destroyed by the company.  These shares have never counted when calculating earnings per share, but are still involved in the float.  In the Q3 quarterly report Sirius XM reported 60 million of these lent shares were returned and destroyed by the company.

Another bond issue Sirius XM might target is the other bond issue needed to facilitate the merger in July of 2008.  These 13% 770 million notes due in 2013 carry a higher interest rate, and are due sooner.  Either way, both have reasons to be targeted first, depending on managements corporate strategy.

Sirius XM was able to refinance most of its 2009 outstanding debt due to Liberty Media’s loan in February of this year.  Sirius XM’s 40% equity stake awarded to Liberty for this assistance is trading in Liberty Media’s holding company, Liberty Media Corporation Capital (NASDAQ:LCAPA).  Other tracking companies of Liberty Media include Liberty Media Corporation – Interactive (NASDAQ:LINTA), (NASDAQ:LINTB), Liberty Media Corporation – Starz, (NASDAQ:LSTZA), (NASDAQ:LSTZB), and Liberty Media Corporation Capital (NASDAQ:LCAPA), (NASDAQ:LCAPB).  Liberty also owns the controlling interest in Worldspace, Inc. (OTC:WRSPQ).

Earlier this month both Liberty CEO Greg Maffei and Sirius XM Radio CEO Mel Karmazin both went on record as saying there is a possibility of a joint Sirius XM/Liberty Media Global satellite radio venture being discussed.  Liberty Media’s acquisition of Worldspace assets paints a clear picture of what these intentions may be.  With Sirius XM proving satellite radio is now a viable business model domestically, expansion of the idea to global markets is the next logical conclusion.  With other parties interested in the satellite radio model for global markets, Liberty and Sirius XM do not appear to be the only believers in a broader market exposure to satellite radio.

Tagging an “over-weight” rating on Sirius XM debt is just one more step to the long term perception that indeed the satellite business model has been validated.

Disclosure: Long SIRI

As I stated in a previous article several weeks ago entitled: “Sirius XM Radio (NASDAQ: SIRI) and Liberty (NASDAQ: LCAPA, LMDIA, LINTA) Pursue Other Markets”, it appears things are heating up for the future plans of the Satellite Radio Company. On November 13^th Liberty Global, another of John Malone’s diverse holdings issued the following Press Release titled “Liberty Global to Acquire Unity Media.”

In the release it states the following points of interest:

1) November 13, 2009: Liberty Global, Inc. (“Liberty Global,” “LGI,” or the “Company”) (NASDAQ: LBTYA, LBTYB and LBTYK) today announced that it has entered into a share purchase agreement with Unity Media S.C.A. to acquire all of the issued and outstanding capital stock of Unitymedia GmbH (”Unitymedia”), Germany’s second largest cable operator.

2) Liberty Global will acquire 100% of the shares of Unitymedia for an equity purchase price of €2.0 billion ($3.0 billion), from its parent, which is owned by a group of shareholders led by BC Partners and Apollo.

3) Liberty Global is being advised by Goldman Sachs in connection with this acquisition.

Looking at things a bit further, we know that Liberty is in discussions as well with regard to Worldspace (OTC BB: WRSPQ) on acquiring their hard assets, this after buying up their debt. On the Worldspace website it states the following:

“1worldspace is the first and only company with rights to the world’s globally allocated spectrum for digital satellite radio. Its broadcast footprint covers over 130 countries including India and China, all of Africa and the Middle East and most of Western Europe – an area that includes five billion people and more than 300 million automobiles. Its two fully operational satellites and ground infrastructure are based on proprietary and patented technology.” (http://www.1worldspace.com/corporate/)

In 2006 Worldspace Italia received approval from the Italian Ministry of Communications to launch a subscription based satellite radio service in Italy utilizing 12.5 MHz of the L Band frequency spectrum, which is the only frequency spectrum band harmonized for satellite radio over Europe. In January 2007, Worldspace signed an agreement with Telecom Italia to design and deploy a terrestrial repeater network through Italy

In 2008, Worldspace signed a contract with Fraunhofer Institute for Integrated Circuits (IIS), part of Fraunhofer Gesellschaft,(The largest organization for applied research in Europe. It includes more than 80 research units, including 60 Fraunhofer Institutes, at different locations in Germany. The majority of the 17, 000 staff are qualified scientists and engineers working under a € 1.5 billion annual research budget .Of this sum, 1.3 billion euros is generated through contract research. Two thirds of the research revenue is derived from contracts with industry and from publicly financed research projects. Only one third is contributed by the German federal and Länder governments in the form of institutional funding .They have research centers and representative offices in Europe, USA, Asia and in the Middle East.) to develop a receiver reference design or engineering blueprint for the European market. The design was already in development and undergoing testing prior to Worldspace going into bankruptcy.

From this information, we can see I think pretty clearly that any talk of Sirius XM Global expansion must include Liberty and John Malone’s deep pockets. While Sirius XM does possess some very unique content and talent, they are still growing and not nearly in any sort of position to acquire the infrastructure and licensing it would take to leverage their content across the Globe. Liberty still very much remains the exact partner and ally that Sirius XM needs to have in order for the possibility of this scenario to flourish, or even be a remote possibility.  There are some engineering issues clearly for the companies to work through, as well as licensing and spectrum issues which must be dealt with. Liberty has been dealing with those issues through Liberty Global and other Liberty companies for many years already, and their knowledge base in that area should not be taken lightly.

Another interesting piece of news from last year;

Also of note is Liberty’s recently announced stake in VIASAT (NASDAQ: VSAT) through VIASAT’s acquisition of Wildblue communications:”Liberty Media to Appoint Representative to ViaSat Board“

At closing, WildBlue shareholders are expected to have the right to nominate one representative to the ViaSat board of directors and have agreed to allow Liberty Media, who is expected to become a significant shareholder of ViaSat as part of this transaction, to select the representative.

“Our longstanding investment in WildBlue reflects our keen interest in new broadband access and media delivery networks of all types,” said Mark Carleton of Liberty Media, who also is chairman of WildBlue. “In just a few years, WildBlue established a demand for its service and rapidly grew to over 400,000 subscribers. We believe that combining the service and technology companies, expanding the market applications, and adding the timely quantum leap in network capacity expected by the ViaSat-1 satellite, establishes an even more competitive platform for further growth and value creation for shareholders.”

You can read the entire press release here:http://www.viasat.com/news/viasat-acquire-wildblue-communications- which was recently given a huge regulatory reprieve with this announcement:

 ”ViaSat and WildBlue Communications have been granted early termination by the Federal Trade Commission and the Antitrust Division of the Department of Justice of the mandatory waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (“HSR”), in connection with the previously announced ViaSat acquisition of WildBlue.” Also: “Completion of the proposed acquisition remains subject to receipt of other regulatory approvals and the satisfaction of the other closing conditions set forth in the merger agreement. The parties continue to expect the transaction to close in the fourth quarter of ViaSat’s 2010 fiscal year, which ends April 2, 2010.”

Full press release at the following link:http://www.viasat.com/news/early-termination-hsr-waiting-period-connection-proposed-acquisition-wildblue-communications

It is possible that all these recent acquisition events have absolutely nothing to do with the combination of Liberty and Sirius XM. They could all be business as usual and have impacts on the Liberty businesses which are involved with them individually only, but given the history of Liberty as a company, one has good reason to think that this is all somehow interconnected. Sirius XM may well find itself subscribers via internet in Europe very soon, followed eventually by subscribers via automobile as in the United States. To that end, Liberty is the key and has the door opening ability and network of contacts to make it all come true. If it does play out, Sirius XM shareholders will be holding stock that is much more valuable than it was when they originally invested in it. Certainly, Sirius XM has much more value as a global media enterprise, than its current US based limited model represents.

Welcome back today for part 2 of the King of all Trades earnings preview in advance of Sirius XM Radio’s (NASDAQ: SIRI) third quarter conference call, which is taking place on the 5^th of November.  In case you missed Part 1, you can find that article here – Sirius XM Radio Q3 Earnings Preview #1.

As Sirius XM entered into the last half of the year, Mel Karmazin, CEO of Sirius XM radio, had given us a $400 million EBITDA guidance, and Sirius XM has only realized about half of this amount in the first two quarters.  Q3 being a traditionally cost heavy quarter (costs increases in Q3 results from charging a large amount of chip related costs, and inventory creation), there are few expecting any EBITDA additions to Mel’s yearly guidance (I think we get some anyway).  Q4, a revenue intensive quarter that should allow Sirius XM to post its first ever fully adjusted profits in its history (Free cash flow has already been achieved).  Mr. Karmazin has alluded that the company will be FCF (free cash flow) positive for the entire year for 2009.  In between this potentially historic earnings report and now is a Q3 that should still show significant improvements in becoming a profitable entity, and allowing Sirius XM to enter 2010 as a potential cash machine for the first time in its long and troubled history.  Sirius XM appears to be finally turning the corner after always being underwater with huge start up costs (infrastructure, satellites, licenses, talent acquisitions, paying forward for future subscribers off the backs of current subscribers, etc..).  Let’s take a look now at the numbers.

Here is a look at the Q2 Revenue line items.  You will see that most of their revenue is generated from subscriber monthly fees.  There is also some advertising revenue as well.

So we see last quarter’s revenue came in at 561 million.  This is a huge jump from Q2 of 2008, of 266 million, as you can see.  Some deferred revenue comes from Promo subs, but realized on the revenue side only when a person is actually paying for that sub, and off the free trial.  Self pay numbers, a new metric Sirius XM has broken down for us this year separates Promo subs (we estimated total subs in Q3 to be around 18,662,424) from “self pay” sub numbers.  Here is a look at this line item in the Q2 report.  You will see this breakdown.

Revenue is generated from this category, the self pay subscriber total numbers.  Since we know around 44% or more of every new sub turned on in the OEM market (new autos) will stay, so growing this base with large promo sub numbers is important.  If you sell 12 million cars, after 3 months to as long as one year from that time (average length of trial subs, as each makers deal is different), you will add 2.8 million subscribers to the self pay numbers (minus churn rate).

I am expecting self pay sub totals to go up slightly this quarter.  These are your hardcore core, the loyal base Liberty fell in love with.   A lot of angry subs have already cancelled due to internet charges, lineup changes, royalty charges, bankruptcy concerns (which is completely off the table for years due to debt restructuring, and a strong cash on hand position), and bitter investor/subscribers.  The remaining self pay numbers have held steady for 2 quarters now during the worst economic conditions in memory.  This bodes well for a return to positive growth in this area.  It will be modest, but I expect an improvement here.  I’m going to give some credit to Sirius XM’s excellent job of customer retention by offering Best Of Packages, new improved internet line up, iPhone/iTouch accessibility, new radios, and new talent (Rosie O’Donnell began airing for the first time this week).  15,500,000 self pay subscribers is the number I am going to use. The trend on self pay numbers right now is that it is holding steady.

Once we know churn and self pay subscriber totals we now can begin to calculate Sirius XM earnings for the third quarter.

Now that we know the proper number of subs to generate our revenue line item from, we will need to get the other side of the equation; how much does each sub generate in revenue per month.  This is called ARPU (average revenue per unit).  Last quarter this metric was at 10.66.   Here is what Sirius XM had to say about this metric’s performance in Q2, and let’s see if we can use some of that information to make an educated guess on what we might be looking at in Q3.

[ARPU. ARPU is derived from total earned subscriber revenue and net advertising revenue, divided by the number of months in the period, divided by the daily weighted average number of subscribers for the period. See accompanying footnotes for more details.

Advertising revenue probably bottomed.  As credit improves, and companies grow again, advertising will pick back up again.  From Q2 Year-to-year, it actually went from 8 million to 12 million.  I think this trend will continue, but it will be a slow recovery for this metric.  As far as Best of Packages, I don’t see this trend stopping  either, as consumers demand the best of both worlds.  It is much cheaper to add Best of package, than to order another full subscription.  Internet charge for Iphone and internet lineup  will also add to ARPU.  It is called “premium internet” service by Sirius XM, and it is a 2.99 charge if you want internet access and use of your Iphone application.  Here is where the app’s true value comes into play.  Of the 15 million core users of Sirius XM, and the millions of people who downloaded the free trial, I believe at least 300,000 of these people have added the 2.99 charge, at least.  I am going low here.  With new internet channels, making internet charge mandatory, and Iphone application requiring the charge, I feel this number may even be low.  So there will definitely be an increase in ARPU this quarter.  Royalty fees will not add to ARPU.  They will hit the bottom line, but not in this line item.

Using trends from Q3’s in the past, and strong current ARPU metrics, analyzing Sirius XM’s own statement on what they attributed their increase to, we can assume a modest jump this quarter in ARPU.  I am estimating Q3 APRU to come in around 10.78.

Subscriber revenue includes subscription fees, activation fees and the effects of rebates.   So using last quarter’s information assuming it’s consistent , and a clear revenue trend is in play, we see how the last few quarter’s revenue has gone for Sirius XM.

Total Revenue in:
Q2 of 08: 283,017,000
Q3 of 08: 488,443,000
Q4 of 08: 644,108,000
Q1 of 09: 586,579,000
Q2 of 09: 590,829,000

The revenue base hit its high in Q4 (as expected) and retraced, but to nowhere near Q2 levels of last year.  Q1 revenue came back strong in 09 with 586 million.  Sirius XM then rose in Q2 again, to 590 million.

Q3 estimate:  Self Pay subs (15.5 million) * 10.78 * 3 = 510 million dollars.

Q2 numbers using the same equation (15.4 million) * 10.66 *3 =  492 million.

Difference of 18 million dollars.

Going to give a 5 million dollar increase as well in advertising revenue, to illustrate the improved economic conditions we are experiencing.  That gives us an additional 23 million dollars in revenue this quarter, from last quarter.

My revenue estimate for Q3 is 613 million dollars in revenue.

Now that we know how much they will take in, we can determine costs, and see what their earnings are going to look like.

Here is a look at their cost line items for Q2 of 2009.

Here is a quick look at how costs have come in the last few quarters.

Total Costs In:
Q2 of 08: 351,066,000
Q3 of 08: 564,561,000
Q4 of 08: 689,752,000
Q1 of 09: 545,918,000
Q2 of 09: 553,594,000

Costs to acquire subs is reflected to a degree in rising costs for this quarter, so SAC (subscriber acquisition costs) will go up from Q2.  A lot of the costs associated with acquiring a years worth of new customers, occurs in Q3.  But maybe not as much as you think.  Let’s break it down.  SAC line above states costs at 67 million dollars.  However in Q4 of 2008, this was more than Q3 of 2008.

SAC:  Q2 of 08: 78     Q3 of 2008:  74    Q 4 of 2008:  71       Q1: 53      Q2 :  57

You can see costs are going down.  SAC for Q3 was 74, but for Q4 it was 71!!

Huge jump?  I didn’t see it.  In fact, if you notice costs from last Q3 and Q4, it actually is higher in Q4!!  Is this a change in philosophy from Sirius XM on how they distribute costs throughout the year?  We shall find out soon enough.

Look at these line items that will occur noteworthy increases in chip and other related OEM costs for new radios and inventory.

The 3 line items of interest here that may see a huge jump in operation costs would be: Cost of Equipment, Subscriber Acquisition Costs, and Eng./Development.  Inventory cost differences Q to Q have been inconsequential.

Here is Q2 2008.

Here is Q3 of 2008.

Here is Q4 of 2008.

Here is Q1 of 2009.

Here is Q2 of 2009.

As you can see, the increases in costs from Q3 to Q4 in these line items is noticeable.

Here is Sirius XM definition of what these 3 line items mean, along with Q2 explanations on why this line item performed as it did.

Cost of Equipment. Cost of equipment includes costs from the sale of SIRIUS and XM radios, components and accessories.

Subscriber Acquisition Costs. Subscriber acquisition costs include hardware subsidies paid to radio manufacturers, distributors and automakers, including subsidies paid to automakers who include a SIRIUS or XM radio and a prepaid subscription to our service in the sale or lease price of a new vehicle; subsidies paid for chip sets and certain other components used in manufacturing radios; commissions paid to retailers and automakers as incentives to purchase, install and activate SIRIUS and XM radios; product warranty obligations; provisions for inventory allowance; and personnel costs associated with stock-based awards granted in connection with certain distribution agreements. The majority of subscriber acquisition costs are incurred and expensed in advance of, or concurrent with, acquiring a subscriber. Subscriber acquisition costs do not include advertising, loyalty payments to distributors and dealers of SIRIUS and XM radios, and revenue share payments to automakers and retailers of SIRIUS and XM radios.

The sentence I have highlighted is going to begin to reverse, as OEM sales are picking up, but still not representing anywhere near the costs to Sirius XM as a 15 million run rate on autos would give.  I would think Mel is smart enough to not need to make inventory for 15 million cars, when the current estimate is around 12 million, bringing us even under the 2008 levels of 13.2 million.  Hence, all these huge increase in costs, I do see some, I just don’t see the “huge” increases investors are warning about.

This metric will go up from Q2.

Engineering, Design and Development. Engineering, design and development expenses include costs to develop chip sets and new products, research and development for broadcast information, and costs associated with the incorporation of our radios into vehicles manufactured by automakers.

This metric will go up from Q2.

Seems like Mel is going to distribute costs more evenly now that the companies have merged.  Due to inventory slow downs from Chrysler, Ford, and GM and the low estimated run rate of 12 million autos in 2010, I am going with lower costs in Q3 of 2009, than in 2008.  Deflation has also hit our country hard, sending Sirius XM supply costs down.  All companies are spending less in 2009, than in 2007, etc….

Cost estimates for Q3 will be 570 million dollars.

Revenue of 613 million dollars minus 570 million in operating costs.  This leaves us with a net gain of 43 million dollars.  Remove a 100 million dollars in accounting charges due to Liberty Loan restructuring and you get an overall net negative 57 million dollar loss, much smaller than Q3 of 2008, YTY.

They will announce .01 cent earnings per share, based on 43 million in earnings, and adjust it to a .01 cent loss (due to accounting charges only).

Summary:
Self Pay Estimate: 15.5
ARPU : 10.78
SAC : Higher than Q2(Under 65)
Revenue: 613 million
Operating Costs : 570 million
Preadjusted earnings :  .01 cent a share.
43 million in earnings.