The Sirius XM Business Model

In the previous article, we learned how Sirius XM Canada was formed from two competitors in the Canadian satellite radio industry, creating a monopoly that enjoys vast revenues but pays no income tax whatsoever.

To understand how this is possible, we are now going to look at the company’s business model, that is, how it makes money.

Revenues

Sirius XM Canada sells satellite radio service to consumers. Its sales grew steadily following the merger between Sirius and XM in 2010, averaging 6% growth per year. They reached $340 million in 2016.

Sirius XM Canada Revenues (millions of $ Cdn)

Only nine months of revenue are included for 2011, due to the merger during that fiscal year.. Annualized, 2011 revenues would have been closer to $190 million.

Most of this revenue comes from its subscribers, about 2.8 million of them, or 8% of the Canadian population. Other revenues include activation fees for new subscriptions, advertising sales, and equipment sales.

The company has agreements with all the major car manufacturers to pre-install its satellite radios in new cars. It offers trial subscriptions to go with these radios, in hopes of getting new car buyers to sign up. If they do, the company shares this revenue with the car manufacturer. So, these subscriptions lead to revenue for Sirius XM Canada and to a revenue-sharing expense, paid to the car makers

Operating and Capital Expenses

In total, the company pays a third of its revenue out for revenue sharing and royalties. In addition to the revenue shared with car makers, this third includes payments to:

  • Sirius XM US for US content that is rebroadcast in Canada
  • CBC Radio for its Canadian content
  • the CRTC to support Canadian content, and
  • musicians, in the form of royalty payments for the use of their songs.

Some these expenses involve arms-length agreements. This means that the company has to negotiate contracts with independent parties who are interested in maximizing their share of the money (the car makers and the musicians’ representatives), or conform to government regulations (the CRTC).

The revenue sharing agreements with Sirius XM US and CBC are different. These are both related-party transactions, that is, transactions between the company and its own shareholders. The only constraints on these agreements are the other shareholders, who presumably would not appreciate seeing their partners drain too much profit out of the company.

In descending order of size, the other operating expenses of Sirius XM Canada include subsidization of radios sold by the car makers, marketing costs, customer care and billing, administration, information technology, its own Canadian programming, and the cost of radios sold directly to consumers.

After deducting these operating expenses, Sirius XM Canada then deducts its capital expenses. These are expenses directly related to running the business, but which involve one-time investments that need to be spread out over time. For example, if the company pays the National Hockey League a one-time fee for the several years’ worth of rights to broadcast games, the expense of that fee is spread out over the length of the contract. The same goes for investments in broadcasting equipment.

These capital expenses are clearly related to running the company. Sirius XM Canada could not offer its services without them. Together, operating and capital expenses leave the company with about 17% of its revenues. This is before deducting the expenses related to financing and income tax. This 17% margin has been growing steadily in both relative and absolute terms. It was only 6% in 2010, when the company first obtained its monopoly, and it has grown in value from about $8 million to almost $58 million.

Financing expenses

The next major expense for Sirius XM Canada is interest on its debt. The company is financed in large part by debt. This debt is privately placed, meaning it does not trade on the financial markets. There is therefore no public record of who holds the debt. Accounting regulations require transactions with “related parties” to be disclosed, and none of these disclosures indicate that the major shareholders of the company directly own any of its debt.

In the two years when the company refinanced its debt, it incurred additional financing fees and losses, but most of the financing expense has been interest. Over the six years that Sirius XM Canada was publicly traded, financing expenses totaled $91 million, or 5% of revenues.

Income tax expense

The final expense for Sirius XM Canada has been for income tax. This averaged 2% of revenues over the six years the company was public, but it fluctuated enormously. In some years, the expense reached 10% of revenues, while in other years, the company enjoyed an income tax benefit (that is, a negative income tax expense).

Income tax expense is normally compared to income before taxes, not revenues, so let's frame it more appropriately. The cumulative income tax expense over the six years was $27.7 million. Comparing this to the income before taxes, which was $104 million, we get an effective income tax rate of 26.6%. This is almost exactly the statutory tax rate for companies based in Ontario.

But wait a minute, didn’t we say that Sirius XM Canada never paid any income tax at all? Correct. I’m coming to that. Until then, let’s remember that an accounting expense is not the same as a cash expenditure. Remember the capital expenses discussed above? They don’t match the year in which the cash investment in broadcasting equipment or NHL broadcast rights was made. This is what accrual accounting is all about: matching expenses to when the corresponding revenue is earned.

Moderate Profitability

Here is a chart of showing how the revenues of Sirius XM Canada were allocated in its accounting statements, from 2011 to 2016. I have laid them out in the same order that we discussed them above. The last segment in the chart is the profit.

 

Expenses and Net Income

This includes all the years from 2011 to 2016.

What we see here is that from 2011 to 2016, the period in which Sirius XM Canada was a public company, it earned a total profit of $76 million. This seems like a lot of money, until you realize that revenues were $1.66 billion. This means the profit margin was only 4.6%. This is all right, but it seems remarkably low to me, given that the company enjoys a complete monopoly. Where did all the money go?

To answer that we need to look at the cash flow statements. Next time…


Correction

I've now clarified the effective tax rate for Sirius XM Canada (26.6%). In the original version of this article, I only compared the tax expense to revenues (2%). While I was trying to explain how all the revenues were allocated, the figure of 2% was confusing for anyone expecting to see a percentage more in line with statutory corporate tax rates.


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