Sirius XM: The best play on an auto rebound

(breakingviews.com) -- U.S. car sales are in a ridiculous funk. Even with a strong June, the current annualized rate of about 10 million vehicles isn't enough to compensate for scrapped cars and population growth. Yet the best investment play on an American recovery may not be a car or parts maker. Curiously, it may be Sirius XM Radio, which operates the radio in the dashboard.

This is partly a process of elimination. Two of Detroit's Big Three -- Chrysler and General Motors (GMGMQ) -- are in bankruptcy. Ford Motor (F, Fortune 500) is, of course, an option. But some 40% of Ford's sales come outside the U.S., so it's not a pure play on the domestic market. True, there are parts companies uniquely focused on the U.S. market. But given the serious margin pressures they face from bankrupt carmakers and rivals they look like very risky investments.

Now consider the virtues of satellite radio operator Sirius XM (SIRI). Nearly all of the $2.4 billion in sales the company should rack up this year come from car owners. They pay around $17 per month to listen to its 300 channels, which include stations dedicated to, among others, the Grateful Dead and Metropolitan Opera; talk radio from left to right; and entertainers like Martha Stewart and Howard Stern.

Its services are only available in the U.S. and to a lesser degree Canada. Moreover, with the merger of XM Satellite and Sirius Satellite Radio last summer, the group has a monopoly on the business. So Sirius XM is more leveraged to a recovery in the U.S. car market than pretty much any car or parts company.

Of course, as investors in Sirius XM found out much to their chagrin in recent years that's not always an advantage when the U.S. market goes south. The company had to refinance a chunk of debt just as credit markets shut. The resulting liquidity squeeze meant it had to turn to media mogul John Malone for an emergency injection of cash in February. This removed concerns the company would default on its $2.4 billion of net borrowings. Only $263 million of debt matures by the end of next year, which looks manageable.

So what could a pick-up in the U.S. car market be worth to Sirius XM? Assume the company increases its 19 million subscribers by 15% per annum over the next ten years to 75 million in ten years' time. That's fast, but achievable. That would be less than a third of all vehicles. In contrast, more than 80% of all homes have pay TV.

Investors currently value cable TV subscribers at about $1,000 each, according to Sanford Bernstein research. Satellite radio subscriptions cost less than half those of television, so let's assume each may be worth $450. At 75 million customers, that's a total value of some $34 billion by 2019. Now a dollar that might appear tomorrow isn't worth the same as a dollar today. So let's discount the value of those subscribers by 15% annually.

On that basis, Sirius XM's future subscriber growth should be worth about $6.6 billion today. After subtracting debt and accounting for Malone's shares, that equates to about $4.2 billion of equity value, or around 65 cents a share. That represents an upside of more than 50% to today's stock price of 43 cents.

Of course, the company has disappointed shareholders before -- and its subscriber penetration goals are indeed ambitious. But investors keen to wager on the U.S. auto industry's rebound may want to switch on the radio.