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Sirius XM Needs to Show Cost Cuts

When Sirius XM reports first-quarter results this week, investors need to look past weak subscriber numbers and instead focus on the company's efforts to manage costs effectively.

Sirius XM

(SIRI) - Get Sirius XM Holdings, Inc. Report

will report its first-quarter results before the start of trading Thursday, and while analysts will be watching subscriber numbers for signs of weakness, cost-cutting may be a better indicator of how the satellite radio giant is dealing with the harsh economic environment.

The outlook for Sirius XM has improved dramatically after

Liberty Media's

$530 million loan infusion

helped diffuse worries the company would be forced into bankruptcy. Shares of Sirius XM have rallied more than 600% to 39 cents from the 52-week low of 5 cents set in early February at the height of the uncertainty.

With concerns over Sirius XM's debt on the back burner, investors and analysts can resume weighting the satellite company's future based on its key metrics -- adjusted earnings before income, taxes, depreciation and amortization, subscriber count, churn and conversion rates, subscriber acquisition costs, and average revenue per subscriber.

On average, analysts expect Sirius XM to post a first-quarter loss of 2 cents a share on revenue of $647.4 million, according to a Thomson Reuters poll of three analysts. That compares to a loss of 7 cents a share in the year-ago quarter, which was before the merger between Sirius and XM, and 8 cents a share in the fourth quarter of 2008.

Sirius XM and its CEO Mel Karmazin have placed a greater emphasis on the importance of adjusted earnings before income, taxes, depreciation and amortization, or EBITDA. Karmazin has asserted that the company will see positive adjusted EBITDA of $300 million in 2009, which would be a significant win for the merged company. Just two years ago, Sirius had an adjusted loss of $565.5 million, which shrank to an adjusted loss of $136.3 million in 2008.

The fourth quarter of 2008 showed strength on the adjusted EBITDA front, as Sirius XM reported adjusted income of $31.8 million, compared with a year-ago loss of $224.1 million. If the company is able to build on that number in the first quarter, Karmazin will likely trumpet the improvement toward his $300 million goal.

Focus on Subscriber Growth

Subscriber numbers will also be very important to investors. In November, Sirius XM offered projections for the next five years, saying it expects to grow its subscriber count to 28.4 million by the end of 2013. The company ended 2008 with 19 million subscribers and said it should finish 2009 with 20.6 million subscribers.

However, when the company reported its fourth-quarter numbers in March,

Sirius XM said it would not make any subscriber projections

given the economic uncertainties, which raised a red flag for some investors who feared the worst.

Keep in mind that Sirius XM is still adding subscribers, just at a slower clip. In the fourth quarter, the company saw gross additions slide 26% and net additions fall 25% from a year ago. Unfortunately, the number of deactivated subscribers ballooned 33%. With all signs pointing to a disappointing number in the first quarter, the question is how bad will the subscriber figures have to be to scare investors.

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It's no surprise that Sirius XM and its original-equipment-manufacturer, or OEM, unit have been impacted by the dramatic slowdown in auto sales. Last week,

General Motors

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reported a 34% drop in April vehicle sales. Rival


(F) - Get Ford Motor Company Report

said sales slumped 32% in the same month from a year ago. The news that


would file for Chapter 11 bankruptcy protection likely didn't do much to help things.

"As automotive sales slow, so does Sirius XM's main source of subscriber growth," wrote Frederick Moran, an analyst with Stanford Group, in a research note. "Satellite radio's growth has grown increasingly dependent on OEM automotive distribution. Automotive sales have fallen to the lowest levels in decades."

Of course, the global economy took an enormous hit in the first quarter, which has led some to wonder how the subscriber numbers held up for Sirius XM.


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, which Karmazin loves to say is a comparable company to Sirius XM, said total revenue generating units rose only 6% in the first quarter, down from 7% in the fourth quarter of 2008 and 10.7% in the year-ago period.

If subscriber numbers are expected to be dismal, investors searching for good news will have to look elsewhere. It certainly won't come from the churn rate, which may disappoint as well. The monthly churn rate for self-pay customers, which measures the number of subscribers who left the service, rose to 1.8% in the fourth quarter 2008, up from 1.7% in the year-ago quarter.

The conversation rate, which measures how many people turned a free trial for the service over to a paid subscription, will also be important. In the fourth quarter, the conversion rate declined to 44.2% from 51.4% a year earlier. For all of 2008, the rate fell to 47.5% from 50.9% in 2007.

"One data point of concern was a significant decrease in the conversion rate," wrote James Goss, an analyst with Barrington Research, in a March research note. "While we are sure that the weak macroeconomic environment and consumer concern about the company's continued survival were at least partially responsible, this trend will be monitored."

The Good News: Lower Costs

Perhaps the bright spot in Sirius XM's first-quarter report will come from cost reductions. In tough times like these, companies do whatever is necessary to reduce costs. For Sirius XM, which merged only months ago, synergies are expected to help cut many of those costs.

When Sirius XM reports Thursday, lower subscriber acquisition costs should garner attention. Subscriber acquisition costs declined nearly 12% in 2008. A 5% drop in gross subscriber additions helped improve that figure.

Looking at the fourth quarter, subscriber acquisition costs per gross subscriber improved to $70 from $83 in the year-ago quarter. If that number improves in the first quarter, much of that move can be attributed to lower gross subscriber additions, but it may still help Sirius XM's bottom line.

Other costs declined in the fourth quarter. Programming and content costs decreased by 4%, revenue share and royalties expense fell by 25%, sales and marketing costs declined 34%, general and administrative costs decreased 20%, and engineering, design and development costs were 27% lower.

On the other hand, customer service and billing costs increased 3% compared to the same quarter a year ago. However, it's the programming and content costs that analysts and investors will closely watch for a change.

"Sirius XM has been unsuccessful in renegotiating some larger content contracts," Moran said. "For example, Major League Baseball reportedly refused to change its contract, which costs approximately $60 million per year for the broadcasting rights. Other large content contracts include Howard Stern, Oprah Winfrey, and the NFL. We believe Sirius XM must devise a strategy to lower content costs to remain viable."