I have been a keen observer of what great investors own in their portfolios. No one has been more intriguing to me than Warren Buffett of Berkshire Hathaway. Historically, Mr. Buffett's investments have been extremely selective, but once they have been chosen by him (or his team), his amazing historical track record means it's a good bet that they will deliver something wonderful to shareholders.
In the fourth quarter, Berkshire took a large position in Sirius XM directly to the tune of 167 million shares, making Berkshire the largest minority shareholder. This equates to about 3.5 per cent of the outstanding stock. Not surprisingly, since Berkshire's disclosure of the purchase, the stock has gotten a big kick upward. Here's why I think they have bought into this business and why it may belong in your portfolio as well. (Full disclosure: Sirius has been an outsized investment for us – almost 11 per cent of our firm's funds – during the past number of years.)
First, Mr. Buffett looks for companies with a sustainable competitive advantage. The company is the only satellite radio service available in North America. Further, no other company has the unique content it provides – news (CNN, Fox, financial news, world news), sports (NFL, NHL, MLB, NBA, NASCAR, PGA and more), music, Howard Stern and so on. The service is received uninterrupted whether you are driving your car in Fort Lauderdale, Fla., or Thompson, Man.
Of course, there's lots of competition, the largest being free radio, which has been around for decades, but it comes with a lot more advertising. And yet, subscribers are willing to pay around $13 (U.S.) a month to receive the service. There are over 200 stations on Sirius, but everyone has their two or three particular stations they become "addicted" to. Services that are addictive (in a good way) are truly great in that they go from being interesting in the beginning to becoming almost a necessity.
Mr. Buffett has always loved companies that are predictable in that he can have some reasonable expectation as to what the future of that business will look like. Sirius possesses an incredibly consistent, predictable foundation. Every year, somewhere around 18 million new cars roll off the assembly line with about 75 per cent of them having the Sirius "infrastructure" built into the vehicles. That translates into about 13.5 million new Sirius cars going on the road. A free-trial subscription for six months gives drivers time to test-drive the Sirius service. After the trial expires, the service abruptly ends – sometimes in the middle of the driver listening to their favourite show. Instead, a phone number appears on the screen, which you must dial to become a paying subscriber. The conversion rate from trial to paying subscriber is about 40 per cent, a very significant number. Mr. Buffett's favourite kind of business is one where the revenue is repeatable and predictable. This is a service where prices charged don't have to be cut to maintain and add new subscribers. In fact, Sirius has raised its subscription price twice in the past few years, while suffering no falloff in subscribers – old and new. And critically, it's a service where customers are less likely to cut off the service if economic times turn bad. Even in 2009, a terrible economic year, the company still added 250,000 subscribers. Now that's a great business. That's what I believe Berkshire Hathaway sees as well.
Here are a few more important stats that show why I think Berkshire purchased Sirius shares. In the past three years, from 2013 to the present, subscribers have increased from 25.5 million to 31.3 million. New car penetration (vehicles with Sirius infrastructure installed) has gone from 70 per cent to 75 per cent. The number of cars with a Sirius button has improved from about 60 million to almost 90 million. Most important, the company predicts there will be about 185 million cars 10 years from now with their service. In 2013, they had about 11,000 used car dealers offering free trials. At the end of 2016, that number had grown to over 25,000. (Used cars are, year by year, becoming a more dominant source of subscribers.) Free cash flow has grown by over 50 per cent from less than $1-billion to $1.5-billion and the stock price is now over $5 a share versus less than $3.50 just three years previously.
So, if you have patience, I think you may do very well investing in this singular venture. Mr. Buffett has said in the past that when you attend a sporting event, you watch the game being played, not the scoreboard. In other words, watch the business as it grows instead of focusing on the stock price. If it's good enough for Berkshire Hathaway, we think it is one you should consider seriously. In my opinion, this is a great "buy and hold" place to plant some money.
Larry Sarbit is the chief executive and chief investment officer at Winnipeg-based Sarbit Advisory Services. Mr. Sarbit is a sub-adviser on three funds for IA Clarington.