Sirius XM Holdings Inc. (SIRI) Earnings Call Transcript

Good morning, everybody. This is Jessica Reif Ehrlich. I'm the media and entertainment analyst [indiscernible] Bank of America Securities. And I'm thrilled to have David Frear, CFO of Sirius XM, with us today. So with tons of questions, we'll stop towards the end to see if there are questions from the audience. But if not, I've got tons of my own. So David, thank you so much for joining us today, and let us just get into it.

Sounds good.

So while Sirius XM -- thank you. So while Sirius XM is a brand familiar to many consumers with nearly 35 million subscribers at your legacy business and roughly 60 million active users at Pandora. Today's audience is mid-cap, is not necessarily focused solely on media. So in light of that, perhaps you can start by providing a brief description of your businesses for those that just aren't as familiar with us.

Okay. So thanks for having me, and, everybody, thanks for taking the time this morning. Business is basically built around 3 things that for the most part center around digital audio in North America. It start with the Sirius XM products, which are linear radio products delivered to over 100 million vehicles on the road today, and both subscription and ad-based streams of revenue. The Pandora business is predominantly an ad-based business in the U.S. and also has subscription products. But importantly, Pandora has a sales representation relationship with SoundCloud, which is a very large digital audio platform globally. And then the third block of products is ad tech services, which, through the acquisitions of AdsWizz and Simplecast, we've added in the content hosting, data analytics and reporting products as well as ad insertion services and digital audio ad buying services. And so through this stack of products, we have solutions not only for listeners in paid offerings and persistently free offering supported by advertisers or advertisements, but also, we offer technology services to both other audio publishers and advertisers to facilitate the sale and purchase of advertisement digital audio products globally.

Right. And so in addition to a strong, stable and growing subscriber-based business model, Sirius has multiple avenues of growth, at least in our view. So what do you think are the greatest opportunities for growth over the next 3 to 5 years? And so let's start with that.

So we're going to -- we're still in the process of building out the enabled vehicle fleet in the United States and Canada. That's for Sirius XM products being installed in new car production that by the end of this year we should be at about 80% penetration of new car production. And we're going to expand the enabled vehicle fleet by another 100 million over the next several years. We'll also have increased opportunity for distribution through the used car market. The penetration rate of satellite radios in used car sales in the country is currently right around 48%. And that is, over the next decade, going to rise to the 80% level. We've also got a continuing shift of audio ad dollars away from the terrestrial radio properties and into digital audio. And the digital audio -- it's not just sort of a zero-sum game between terrestrial and digital audio. The pool of the advertiser dollars being dedicated to digital audio is just flat out growing. And there's great growth there. And then with the tech and sales representation services that we offer through Simplecast, AdsWizz and Pandora that we've got a great opportunity for growth in the, what we call, the off-platform business. That is products monetized without a listener being either a Sirius XM subscriber or a Pandora listener.

And then on the opposite side of that, what do you see is the greatest risk to Sirius generating sustained growth? Is it car sales because of the economy? Pandora has been somewhat of a challenge? Or what about renewing how it's churned? Where do you see the greatest risk?

When we came into March, we thought we were staring at the greatest risk right at that point with global pandemic taking off and recession that was going to come and did come on the heels of it. And it's just incredible how resilient the business has been through this. Performance has been outstanding. And so right now, I'm scratching my head a little bit as to what, in fact, is the greatest risk. Jim and I have been worried about recessionary effects on the business for a couple of years now. They had this historic long recovery in the U.S. economy. And that, of course, was shattered in the spring. And shattered enough that for the first time since we started providing guidance, probably 16, 17 years ago, we suspended it. And 3 months later, we think we're back to where we've got a solid view, and the business has performed extraordinarily well throughout it.

Right. And as I mentioned earlier, your legacy Sirius XM business has nearly 35 million total subscribers, which includes 30 million self-pay subs. Can you explain the difference between self-pay and paid promotional subscribers?

Sure. The paid promotional subscribers are part of what we would call top of the funnel, right? The -- some automakers have chosen to either for economic reasons associated with the contracts we've negotiated with them or for marketing reasons because of the length of trial they'd like to have, but they've chosen to provide a subscription to their customers that buy the new cars that they, in turn, buy the subscription from us, the automaker does. Most automakers, probably 75%, are on unpaid trials, 3-months unpaid trials. So what we're doing is we're always looking at the top of the funnel, how many trials are we starting either in the new car, the used car business? Are they paid? Or are they unpaid trials? And then we have marketing programs that convert those people from the top of the funnel into self-paying subscribers where they give us a credit card or a debit card, and we build them a recurring charge. So the paid promotional subscribers just reflects that proportion of, for the most part, new car transactions that the automaker has chosen to pay the company for the initial trial that's given to the consumer with the purchase of the car.

Okay. And COVID-19 is likely -- so many changes across the society and business. For Sirius, investors are focused on potential changes to commuter and vacation travel. As people potentially will take less public transportation and also subsequently car transport, air travel, what -- can you comment on how you see these factors impacting your subscriber growth? And how does COVID-19 impacted your strategic plans or cost structure and your business overall?

So the driving patterns, there was clearly -- and I think it was reported in a lot of places, huge drop in driving throughout the U.S. right after the shutdowns set in. And -- but it really -- it's been steadily rising back. And the interesting thing about is right from the beginning it's sort of leveled out the week, right, that the commuting patterns -- what was it, somebody said to me the other day, every day is a weekend. And it's not quite like that. But you know what, it's not very far off that. It really has sort of evened out the distribution of how people move around across the week. And listening has followed along with that. So we get a bunch of data back from our 360L vehicle. And we found a -- just a really significant drop of trips longer than 45 minutes and a really significant increase in trips of less than 10 minutes. And so with that, people, they're selling their cars a lot. They're not on them quite as long, but they continue to listen. And I guess the sort of hidden benefit of all that is that it's really promoted deeper engagement with our subscribers by spurring in-home listening. And we've seen both on the Sirius XM products as well as the Pandora products really significant increases in listening through consumer electronics devices to in-home devices, the Alexa and the Google Home Hub and things like that. And we've seen on the Sirius XM side where we struggled in even getting our subscribers to remember that they could stream for free through us, that subscriber streaming has doubled in the course of last year. And one of the things we know about any product, if you use a product a lot, you tend to keep it. And so deeper engagement, I think, is really tied into the great churn rates we're seeing. Other things about COVID-19, we put a hiring pause in place right away. We've opened that up just a little bit, but that will result in a sort of a slowdown in new projects. We're still working away at and still investing in all sorts of new initiatives within the business, but we're going to take a little more time to get there, taking a very hard look at T&E. The whole Zoom world has just gone incredibly well. The business has operated really well as you were able to see in the second quarter results. You see it with our guidance. And we're working very effectively from home. And that's going to cause us to take a look at in the long term whenever there's a medical solution that let's everybody begin to move around again as normal, that what level of T&E is appropriate for the business? How much office space do you need? We'll rethink those things. We've seen the increased use of chat agents as well as work-at-home call center agents out in the field to deal with the operating environment that we have in call centers around the world. So virtually all of our call center personnel are -- we get from third party. And there, we have a lot of capacity in the Philippines. We have a lot of capacity in Central America and some in the U.S. We have chat agents around the world. And there's been a redistribution of that workload to deal with the fact that it's tougher to get people into the call centers around the world given sort of rolling ways of the disease. We're also seeing our teams are taking a hard look at accelerating the employment of things like robotic process automation in all sorts of different parts of the business. There's a lot of ways you can use this in accounting and finance and marketing campaign to make your execution more efficient. And I think as it relates to COVID, that's probably a pretty good summary. I mean we're kind of at now this new normal, right, not only for how we operate, but for how our customers operate. And those new patterns of behavior are becoming pretty evident in the business.

A lot of changes. Self-pay net adds remained positive in the second quarter. Your subs are actually really great. Churn is very low. But the third quarter, the trial funnel will be negatively impacted by the reduced car sales in the second quarter due to the various state lockdowns. But it seems like car sales are rebounding better than most had expected in the current quarter. What is the company's view on auto sales for the remainder of the year and as you look out beyond 2020? Do you have a point of view?

So we -- for a long time, we've just sort of taken the average of the analysts who covered the U.S. auto sector. While we could try and engage our own forecaster or people who have spent decades doing that, and their guess is as good as anybody. So at the time we came into the call a couple of weeks ago, the analysts were saying that they thought the year for U.S. auto sales was like 13.2 million. I mean July was phenomenal considering over at a couple of months ago it was 14.5 million. The 7 months are already at 13.2 million. So to me, it looks like there's upside to the 13.2 million that the -- is the consensus with the analysts out there. 2021 is still hard to see. I mean our -- we've got this healthy ramp. Coming off July 14.5 million is a good sign. Are we going to get back to 16.5 million? I think it's hard to tell. It's -- one of the things we have to remember is that probably about 15%, 18% of U.S. automotive production has traditionally been fleets and rental vehicles. The -- with what the pandemic has done, the travel has done to the rental car business, you have to believe there's a big chunk coming out of U.S. auto sales associated with defleeting of the rental car agencies, and they won't be buying as many cars in the future as they have in the past. But that doesn't really affect consumer sale, right? So if you figure there are a couple of million cars that sell to fleets and rental vehicles, all that would say is that consumer sales that may be 14.5 million was a robust year. And it's going to be really interesting to see where the consumer sales settle out as we get to the end of the year. So -- and I think we're going to have to look in the future a little bit under the SAR and look at the composition to get a read on what it means for our business. And the consumer, to me, they look pretty healthy right now.

Can you talk a little bit about churn, conversion rates as well as your overall expectations for both self-pay net adds for the second half, but also paid promotional channel as well?

Sure. See, I mean, honestly, churn is -- really just blown us away. Never in our wildest dreams would we have expected 1.6% for the second quarter given what we went through. And we got -- we were really surprised at the level of nonpaid churn. And it was at these really healthy levels when the economy was charging. And nonpay churn is -- on a rate basis is flat or down. Voluntary churn is up a little bit, but with a reduction in car sales. The vehicle-related churn has been down significantly. So you might remember the -- 10 years ago or 12 years ago, I guess, was now when we hit the financial crisis. That churn which had been in sort of the 1.8% range spiked to something over 2%. And we're just not seeing the spike this time around. So we do have much bigger business. And it looks like things are just sort of leveling itself out. I've heard from other subscription providers that they are similarly seeing very low rates of nonpaid churn. Maybe it's related to the fact that overall consumer spending has been lower, but really pleasantly surprised. Used car conversion rates have really been solid. We haven't seen any deterioration in them at all. The new car is a little soft, but not in an alarming way. And we've seen a lot of strengths in what we call our win-back campaigns as well as the performance of streaming subscriptions. So it's -- all in all, it's been pretty good.

Great. And outside the vehicle, what is key subscription or the key channels that you offer your service through, whether it's Amazon? How are others -- how well like of an opportunity do you think the out of vehicle market could be for the company? And what steps do you have? Like what are you thinking of in terms of attracting more out of vehicle subscribers? I mean you talked a little bit at the beginning about engagement, and this is clearly an area where you drive that.

Yes. There's a lot of people to partner with out there, right? On the equipment side, you've got the Amazons and the Googles that can help you partner with Roku or Samsung. And on the distribution side, cable operators and carriers are looking for products to bundle and use as promotional vehicles. So there's an awful lot of activity between the business development teams on our side for both Pandora and Sirius XM products as well as the business development teams with our distribution partners. It's one of those things. It's hard to put a -- I don't think any of them individually are a kind of a -- be like a major new channel of distribution. But as you look at it collectively and when you think about the number of things, the number of options that consumers have out there, having your product represented in one way or another frequently, with a lot of repetition, a lot of reminders is important. And it's funny that some of these tenders strike accord and will end up with new subscription opportunities that come out of them or an increase in ad-based listening hours on the Pandora side. But some of them actually is just -- it reminds the people that already have a long subscription relationship with you, oh, I can come out of my car in the time that I run -- that I made to go to the drugstore. And whatever program I was listening to, I can pick it up out of my Alexa when I get at home. So that constant reminder is important. There's a lot of things we're trying out here as we experiment with pricing, packaging and promotion. And the prestreaming thing that we did in May and June was, in our minds, a huge success. We're still reading out the actual subscription results from it. But we got great engagement, not only from our subscriber base with new trialers, but probably most importantly, Jessica, from the creative community who was really looking for an opportunity outside the paywall to connect with their audiences. And so all these new channels and shows that we launched during that period and the participation that we got from the creative community in that was incredible. And it's that sort of thing. We've been doing this for years. And it doesn't matter whether it's the NFL is a brand that connects with its fans or a Prince channel that connects with its fans. The -- or Ricky Gervais doing things on his -- doing a show on his favorite Prince song. That all of those things connect with an audience out there. And what happened in the course of May and June is just incredible.

And then let's turn to subscription a little bit. In February 2019, you completed the acquisition of Pandora. Talk about the strategy behind that decision. Why did you acquire Pandora? And where do you see the best opportunities for Pandora, zoning -- let's start there.

Okay. So to be in the audio market in North America, which is where we started, is that you have to be in the ad-based free business. The -- we carved out a really nice niche with the Sirius XM products, grew it to great size with the 32 million self-pay subscribers between the U.S. and Canada. I mean that was great. But if you really want to get to the biggest audience in North America, you've got to be in the persistently free business. And there are 3 ways to do it. We could have done it organically and putting up products on the inactive satellite radios, but it's going to take you a solid decade to begin to build scale there. You could buy your way with an AM or FM radio company or you could buy a digital audio player. And that's what we chose to do. We picked Pandora because it had a scaled audience. It was a -- it had a scaled digital audio sales operation and scaled ad tech. And then since making that initial investment, the Pandora acquired AdsWizz to advance its ad tech as well as add the ability to serve other audio publishers with ad tech. We acquired Simplecast in June who has built a great product for hosting podcasts and providing data analytics and reporting on those podcasts. And it plays very well with AdsWizz. AdsWizz and Simplecast have been pitching. They're jointly pitching their services to audio publishers around the world. They have seen great success in that. And now we had Stitcher, which adds critical capabilities for the production of podcasts as well as the sales of advertising on podcast. And when you take it all together and remember the SoundCloud relationship that Pandora entered into where SoundCloud runs its North American audio inventory through Pandora's systems, and then it's sold by the Pandora's sales force, that we have a full stack of services to offer audio publishers and advertisers, ranging from content hosting to data analytics to ad insertion, campaign planning and sales representation. And with Stitcher, we expand all this, again, at scale to the podcasting universe, providing what's really the first opportunity for advertisers out there to efficiently execute audience-based buys in this expanding space. The challenge -- when you go around and you talk to podcasters. And they say, geez, what's your biggest sort of challenge right now? And because they can sell plenty of host-read ads. They can sell plenty of ads on a show basis. But they'll all tell you that we don't have programmatic products, and we can't do an audience-based buy. And so they can get the direct response guys who will buy in the show basis. And I talked to one guy a couple of weeks ago. And say he can handle $500,000 orders all day long. He can't handle a $5 million order because there's not enough audience reach to efficiently execute that order without running into the frequency capping restrictions. And so when you take all these things that we've put together that you really, for the first time, offer advertisers and brand advertisers, large campaigns, the kind of reach they need to efficiently allocate the dollars there. We think this is going to be huge.

Okay. And then just maybe just kind of a general advertising question. You scaled it so dramatically with Pandora -- your advertising capabilities with Pandora. Can you talk about like where Pandora and Sirius's advertising businesses are now in this environment? How do you view the advertising market overall? And then in terms of -- let me be -- you have a side of that on the cost structure. Well, I guess, we'll do with the advertising question first, and then we'll go to content question.

Okay. The advertising thing is we feel like we're seeing a shift of dollars to digital audio. And some of those dollars are coming from analog audio budgets, and some of those dollars are just coming from the general pool. The digital audio marketplace, I think, in terms of the U.S. advertising market, it's just so large. And when you hear the digital audio numbers, also you can think of is, oh, that's so small. So Pandora does $1 billion of advertising on its own platform. With SoundCloud, it's something like $1.3 billion a year. But in North American ad market, it's like $225 billion right? Yes. It's so small. And so if you add up everybody in the -- and keep the terrestrial dollars out for the moment, if you add up everybody in digital audio, it's a $2 billion marketplace, right? And it's just -- so it doesn't take much in terms of dollar rotation from budgets to provide for a great growth opportunity there. And there's an awful lot of interest from advertisers reaching people in audio form. And I think we all know share over year is just growing. The total -- the big thing about streaming and podcasting all the products that go within that as well as satellite radio is that total listening is increasing, and the ad dollars are going to chase it.

Right. And then before we move on to podcasting, so in terms of content cost, like if you think about the Pandora and Sirius combined, is there any benefit to the cost structure from the legacy Sirius satellite business and putting Pandora together? What comes out of that?

Well, you do have different cost structures that really get to different monetization rates for the products. I mean with an ARPU of around $14 on the satellite radio products, we do an extraordinary job in those products of monetizing. And even though when you work your way through how much audio content gets consumed, that we probably, on the Sirius side, pay some of the highest rates in the world per song play, right, or per song consumed. The -- but we can afford it because of how well we monetize. So if we're at $14 and you know for the paid music streaming products, they tend to average something around $5 a listener. Maybe it's a little bit less now. I think Spotify's numbers have dropped below $5. And if you load up the prelisteners on top of it, that the monetization rates look more like $2 a month. It's -- when you have a cost in that business, which is largely based on the number of the songs you play, the songs that are consumed. If your monetization rates drop, your margins gets dropped like a stone. You saw that happen to Pandora in the second quarter. But as those ad sales come back, you'll get a pretty healthy expansion of margins because they'll -- as the advertiser dollars flow back in and people realize that they need to connect their brands with consumers, advertising demand is, in fact, picking up. And the margins will expand back. But the margins that -- on the satellite radio products are going to be stronger because monetization rates are so much higher.

Then let's go a little bit about podcasting. It's the topic that comes up with all of the audio companies today. It seems to be everybody's big focus. You've made some acquisitions. We've already discussed Simplecast and Stitcher. Can you talk about your kind of longer-term goals for podcasting? You kind of discussed the acquisitions and how it helps you in advertising. Are there any other assets that you need to achieve whatever your goals are?

We might -- I don't know that we're right about this, but we think we're right that we think podcasting is just another form of talk. And that we all know from nearly 100 years of radio history in North America that what people want to consume is a mixture of music, talk, news, sports, traffic, weather and entertainment. That's what they want to consume. And so you got to offer that broad spectrum of products. And you can choose to just focus in on 1 or 2 or 3 of them. But there's -- once you build the platform and you build the distribution, you build your listeners for one of them, might as well extend it to all. So podcasting actually is -- to us, it's just an evolution of the talk program that we've done incredibly well on the Sirius XM product side. And building that into the Sirius app, building it into the Pandora app, and now the -- we have the Stitcher app. But then again, we have these other services. So you can monetize the listener base and you want to put this broad spectrum of products in to maximize the listeners. But there's absolutely no reason with all these scaled capabilities we have in sales representation and tech to not offer those same services to -- backbone services to basically all audio publishers who are trying to amass a listener base.