Sirius XM Holdings Inc. (SIRI) Earnings Call Transcript

Why don't we get started. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures or at the registration desk. I'm Ben Swinburne, Morgan Stanley's media analyst, and I'm excited to welcome back to the conference Sirius XM. And to my left is David Frear, who is the CFO of Sirius, a role he's had since 2003. Dave, thanks for being back.

Thank you for having us.

Before we dive in into the business, anything you wanted to open up or talk about?

Yes. Maybe just -- I mean the business is obviously going pretty well. And all the news has been about the coronavirus. So what does it mean for us? Well, we've done a bunch of things operationally because you really don't know where it's going. So we've got sort of tiger teams in place to make sure there's adequate at-home work capabilities across all the different product lines that we've got. Guys who figure out staffing in the event people can't get to offices, how do you cover all the bases to keep all the wheels running and turning. We did -- we asked our employees not to travel internationally. That's not a huge thing for us. We do have a bunch of call center operations in the Philippines. So it's not a major thing. We've checked supply chains with the OEMs. And honestly, things look -- looks pretty good. The supply chain for automotive is fairly long, as I think most people know. And so if it goes on for a couple of months, I think there's probably not a whole heck of a lot of impact on us. If it goes on for much longer than that, where people can't get in, we can't get printed circuit board supply, right? That could be an issue. But it's got to run for a few months before we think we start to see anything. So other than that, it's just keep cracking away the business every day.

Right. So let's talk about the business. You guys reported your year-end a while ago. Your tenth straight year, I believe, with 1 million or more net adds. This is a business that supposedly was going to be competed away by other technology companies. Maybe you could talk a little bit about how you guys are driving that kind of consistent growth over a very long period of time, even as the business gets bigger.

Yes. It's constantly looking back at what we're doing and looking for the next thing to do, right? And so we have these presentations that we do internally that sort of show -- it's one of those colored charts that shows maybe what the graph might have been for subscriptions if we followed a baseline from 5 years ago, and then it layers on what initiatives to sort of to add the things. And so whether that initiative is going after automakers for increased penetration rate, going after what we call signaling initiatives in the used car market to make sure that used cars get turned on, adding Internet listening as a free as opposed to a paid option, right, with the service. And then variety of other sort of operational things. And it's constantly relooking at that stack of how we do business that continues to expand the growth profile for us.

One of the things that's been a nice trend line over time has been churn. You guys have kept churn low and actually brought it down a tick over the last couple of years. You and Jim have talked about that as an additional opportunity from here. I mean it's not a high churn rate at an absolute level. But where do you see the pockets of opportunity to drive churn down further? It's obviously would impact net adds a lot.

Well, it's a -- I mean it's getting tougher, right? You can see -- I don't think we ever expected to be at 1.7% to 1.8% for -- I think it's been like 7 years now. And we kept guiding that you should expect a 1.8% to 2% churn rate. And what was underneath that was we knew that vehicle turnover would rise as the car fleet aged. And we didn't expect the voluntary and nonpaid churn to come in as much as it has. So I think when we started talking about 1.8% to 2% long-term churn guidance, the non-pay and other voluntary churn was maybe around roughly 150 basis points. That's come in to be inside of 120 basis points now. And so that's helped the overall get flat. How much lower can it go from there? I mean on the -- I didn't expect to get it this low. So I wouldn't think there's a whole lot of room there. But that being said, as 360 outcomes into the car, and we removed some of the friction associated with retaining people, we get more information about how people are interacting with the product that, we think there's still room to optimize a little bit further.

Do you have a sense based on what you know today as to what's driven that improvement in voluntary churn over time other than the products?

Yes. The answer is the products, right? People like what they hear when they turn on the radio.

The other thing that has come up over the years and continues to come up as either a risk or an opportunity is sort of the growing connectivity we all have all the time and increasingly in the car, although that's going to be a slow roll for a while. But I know you and Jim talk about connectivity as a tailwind or an opportunity in the business. I worry it's going to eat away at the exclusivity you have in the dash. Why do you view -- or how do you guys position yourself to benefit from what is obviously an inevitable move towards a connected car?

Well, I've got to tell you that first, with the smartphone coming in, then with Apple CarPlay and Android Auto coming on top of it, right, the distribution opportunity for service providers who stream is -- their distribution footprint is far bigger than ours is. And there are -- there's over 250 million smartphones on the street in the U.S., every single one of them can plug into a car pretty easily. And Android Auto and Apple CarPlay, I think, are 90% of production now. And that makes it even easier. So the competitive impact of all these other people kind of eroding that "exclusivity", which we don't think ever really existed, but we understand other people believe it did. That's a competitive fact that's been reflected in the numbers for years now. And with connected vehicles coming, 360L rolling out, that actually puts us at a place where we think we begin to develop a competitive advantage over these other competitors we've had in the vehicle for a long period of time. And that's a -- we've had to compete with them and their unlimited service potential with a product that is inherently limited in the number of audio channels they can deliver. That's no longer true. And we've been blind to how people were using our product to this point other than surveys that you might do. And as connected cars roll out, we'll finally be able to begin to see exactly what people are doing with the radio. And so having the additional content capability as well as the enhanced information set coming back is what people are doing. We think we can turn the dials and optimize our performance.

Got it. No, that makes a lot of sense. Where are you guys investing in the business incrementally these days? I mean I know there's been a lot of announcements on the content front, in particular, you mentioned 360L. Where are you guys leaning in to sort of make sure the mode stays deep?

Yes. I have to tell you it's everywhere. I mean the -- we've all seen the benefits of an incredibly robust American economy for a really long period of time. And we have not been shy in the last couple of years in investing in -- heavily throughout the business. And to be honest, we could have milked EBITDA much higher than it is by not investing, but we think the right thing to do is to push the technology. So yes, you see new content investments like the announcements that we had last fall, like Drake coming this year. There's -- whether it's these promotional events like Pearl Jam coming to the Apollo, the U2 channel that we have come in that -- it really is sort of a never-ending pursuit of new content. There's a lot of work going on in the podcast side. We're constantly revitalizing the lineup on the talk side. And so a lot of it isn't necessarily these big headline brands that you can put out there, like a Drake, right? A lot of it is done at a show level, and with talent who has a voice. So there's an awful lot going on in content. There's a lot going on in the basic tech front. So with Pandora, we are investing heavily in CPs organization over how the set of SiriusXM and Pandora products...

CP?

Chris Phillips, runs engineering force. Sorry. The -- how the Pandora products and the SiriusXM products will work together well in the car as we go forward. There's a lot of investment going into all platform ads -- ad technology and developing the all platform business, the collaboration that Pandora has with SoundCloud through our -- what we call our [ Packs ], product to Pandora audience exchanges. We think a harbinger of things to come for other players in digital audio, who's based on listeners and ad sales capability aren't really big enough to take advantage of the incredible demand there is out there for digital audio advertising. And so it's -- it really isn't across-the-board thing. The consumer electronics distribution. So the smart speakers at home relationships with Google and Amazon. So there's a lot.

You mentioned before, you could have milked EBITDA even more. You guys have been growing margins, even with all this investment. Is that something you think continues over time?

Yes. I mean it's funny. We said this a long time ago when we -- it's probably 10 years ago or something that, we put out a 40% target for EBITDA, right, that predated the Pandora acquisition, right? And -- but we always said along the way that we'd be happy to sacrifice that target if a lower margin was going to generate more total free cash flow. And at the end of the day, what are we trying to do? We're trying to maximize the amount of free cash flow that we can drive out of the enabled vehicle fleet in the U.S. and Canada.

Yes. But the incremental margins on the satellite business are still pretty attractive. And that hasn't changed structurally, right?

Yes. They are in the incremental margins in the -- especially in the free tier, the Pandora business, were pretty attractive, too. So there's still a good amount of leverage. But to really get the benefit of that, you can't be afraid to invest along the way.

Right. It's not new, it's happened a year ago, a year plus. But Toyota taking you guys' standard I thought was a big deal. We've seen some other OEMs follow suit. What do you see as the long-term trajectory for your penetration rate in new vehicles, given what's happened? And why does Toyota make a decision? Why do you think that's a good one for the business?

Well, so both sides will make more money by them going forward. So it's always what's rooted in that, right? And we'll get to 80% penetration of the North American automotive production this year. Can that drive higher that it could? It really depends on what the auto -- other automakers decide to do with rolling this out. It is a topic that we keep current in all of our OEM discussions, right? That where are you going with penetration? What do you want to do? And we're always looking for ways that we can optimize the terms that encourage them to go farther, where it's not just us buying more production because we don't want to do that, right? That -- we want to be one of these things where both sides make more money. And I think that's a formula we've been able to successfully follow for a long, long time.

Yes. I mean you used to talk about maybe the negative of being standard is if you're in low end trends that aren't converting because of the SAC you incurred. Have you got to a place where you're navigating that now successfully financially?

Well, I mean the SAC has come down like a stone, right? I mean we're somewhere down around $20 now. And the math was different on those lower tier models when you're -- when it was $50 a car or $80 a car, right? But at $20 a car, it's easier to make that formula work. So that -- just good consumer electronics hygiene, right, in driving down the bill of materials on your product and reengineering the product continuously to get more capabilities out of the same price point. That tends to pay off the benefits.

And David, on the used car front, as you guys move -- as your fleet moves from the certified pre-owned into that sort of independent dealer all the way into person-to-person sales, what are the big opportunities left for you guys to get better at converting trial starts and conversion and used?

Well, the biggest single thing we still work hard at, and that's a struggle, is making sure the radios are on when they're sitting on the lot, right? And so we have a variety of initiatives underway there. It's this category we call signaling initiatives, but there are all sorts of subprojects that go into it that have to do with the cadences that you send signals out at and the amount of bandwidth you devote to it. Other things are more operational, like signing up many [ repeater ] sites and auction houses. So as they roll in the cars through, you can hit them and they go live there. And this problem is ultimately one that goes away, but it takes a really long time that. If you think about the connected car, when we ultimately have that, we'll know whether the radio's on, right, but it will take a long time for that to roll out. So we're just keep hammering away at it. One of the things is we have an interesting test in the market with automation where they're deployed a product of ours that came from automatic labs who we bought a couple of years ago. And it's a device in the vehicle that provides all sorts of information not only to the dealer, but to the consumer and through which they can provide service alerts. And so we've got something going on there to see if that isn't going to drive a higher level of service calls to automation than they've experienced before. And just doing little things like that, it tightens up the relationship. The one magic bullet that would solve the cars not being on the lot is if we could get dealer personnel to just co activate it.

You could pay them.

Well, there's a tool that's easy for them to do. They get a free trial for their customer. And the -- so it's more of a guest experience thing. And we think that by working with them a little closer, we can get them to do that more often.