Sirius XM upped its forecast for net subscriber growth for the third time this year.
The satellite radio company announced on Wednesday that net additions in the third quarter jumped 34% to 445,921% from 3334,000 in the prior-year period. Sirius ended the third quarter with 23.36 million subscribers compared to 21.35 at the same point a year ago.
As a result of the strong quarter, Sirius raised its forecast growth for 2012 to 1.8 million from 1.6 million.
Sirius CEO Mel Karmazin called the subscriber growth the best third quarter since the merger. The company will release earnings for the third quarter on Oct. 30.
Sirius XM bears little resemblance to its financially challenged predecessors, Sirius and XM. The company earned a net income before taxes of $248 million and $255 million in the first six months of 2012 and 2011, respectively. That's a run rate of more than $1 billion in earnings. Not bad for a company that needed its royalties lowered by the Copyright Royalty Board in 2007.
Although it has improved its cash position, Sirius XM has been trying to lower the royalties it pays for the performance of sound recordings. It reached out to record labels in hopes of negotiating direct licenses in 2011. In a letter to record labels from Music Reports, Sirius XM offered to pay 7% of gross revenues. Sirius XM pays 7.5% of revenues to SoundExchange this year and will pay 8% next year, although SoundExchange distributes 50% to labels and 45% directly to artists.
Earlier this year, Sirius XM filed a lawsuit against SoundExchange and the Association of American Independent Music for allegedly interfering with its efforts to obtain lower royalty rates by seeking direct licenses.
Bank of America Merrill Lynch analysts feel the company has a lot more room to grow. Bank of America initiated coverage of Sirius XM last week with a "buy" rating and a price target of $3.75. After this week's announcement about third quarter subscriber growth, Bank of America bumped up its price target to $4.00 on Thursday, a 46.5% premium over Thursday's closing price of $2.73.
Bank of America sees Sirius XM's EBITDA and free cash flow averaging 20% and 35% annual growth rates through 2016, respectively. Artists and labels hoping to see some of that upside should take note that Bank of America expects the company to return value to shareholders: "We expect [free cash flow] generation will be returned to shareholders in concert with a healthy leverage ratio of 3-4x," a Bank of America research note said.
Back when the Copyright Royalty Board reduced Sirius XM's royalty rate, the decision was made to set the rate in a "zone of reasonableness" less than 13% of revenue so the company could attain EBITDA profitability and positive free cash flow.
Now Sirius XM is swimming in free cash flow and royalty rates have barely moved upwards. Its stock is a favorite of analysts and investors are likely to follow. It's no wonder why Sirius XM started taking such bold moves to keep its royalties low: its zone of reasonableness is considerably higher than it was five years ago.