from Barrons
d Idea
Satellite radio is here, and XM looks like a winner
By ANDREW BARY
ON A TYPICAL DAY, America's 200 million adults listen to
the radio for at least two hours, mostly in their cars. But
many spend much of that time fiddling with the tuner,
struggling to dodge a ceaseless barrage of commercials
or simply seeking an airwave favorite, be it Howard Stern,
J.Lo, Sinatra, Ja Rule, Streisand, Dolly Parton, Eminem, All
News All the Time or Wolfgang Amadeus.
This presents a great opportunity for two publicly traded
upstarts: XM Satellite Radio and Sirius Satellite Radio,
both of which provide about 100 digital channels with
nearly seamless coast-to-coast coverage, few, if any,
commercials, and far broader choices than what's
available on local stations in any U.S. market.
Fans of XM and Sirius say they offer a potent alternative
to conventional radio, which has grown increasingly
homogenized. About 70% of the nation's 13,000 radio
stations employ one of five formats: country, oldies, adult
contemporary, news/talks/sports and religion. The
average station carries a painful number of commercials --
13 to 17 minutes an hour, on average -- and more during
peak "drive times" at rush hour. And because
conventional radio is still wedded to archaic analog
technology, its sound, even on FM, is of middling quality.
And, as any driver knows, even the most powerful
stations have limited geographic range.
Classical music is disappearing from the airwaves, and
jazz is hard to find. Even popular youth-oriented styles
such as heavy metal and hip-hop have few dedicated
outlets. And forget about finding stations focused on just
Broadway show tunes, folk music or the blues. In
addition, even if you find a station that plays the music
you favor, your choices may be limited. Many music
stations have slashed their playlists, on the premise that
people want to hear the biggest hits several times every
few hours. In some markets, Top 20 radio has
supplanted Top 40. In contrast, the music playlists on
satellite radio include a million songs.
XM, which has 70 music channels, and Sirius, which has
60, offer lots of choices, including classical, jazz, reggae,
blues, many types of rock and other music broadcast
around the clock (see table). Sirius has no commercials
on its music channels, and XM is commercial-free on half
its music stations and has limited advertising -- about
two minutes an hour -- on the others. The pair also have
talk, news and sports channels, including CNN, Fox News
and CNBC, as well as foreign-language, mainly Spanish,
offerings.
A motorist can travel the 3,000 miles between New York
and San Francisco without losing an XM or Sirius station.
The cost: $300 to $500 for the car radios equipped to
receive the satellite broadcasts, plus a subscription fee.
XM charges $9.99 a month for its service; Sirius, $12.95.
Vehicles equipped with satellite radio also have
conventional audio equipment, including AM/FM receivers
and CD and tape players. After years of development --
and some delays -- satellite radio is drawing raves from
its still-small subscriber base for its musical variety and sound quality. And one of the
services -- XM -- even looks as though it's worth a bet by investors who can tolerate
risk.
XM had 347,000 subscribers at year end, while Sirius
had just under 30,000. XM has a head start over
Sirius, having been launched in September 2001, nine
months earlier than its rival, whose debut was delayed
two years by technological problems. More important,
XM is getting a big push from General Motors, which,
more than any other vehicle manufacturer, is
aggressively promoting satellite radio as an option in
its vehicles.
XM expects to have more than one million subscribers
at year end; Sirius, about 300,000. Satellite-radio fans
believe it could become this decade's hot new
consumer-electronics product, ultimately boasting 30
million subscribers. They see satellite radio becoming
standard equipment in new cars, just like AM/FM
receivers.
XM and Sirius each need two million to three million subscribers to achieve break-even
financial results. Above those levels, the economics become very favorable because
satellites can service an unlimited number of subscribers. XM aims to break into the black
in 2005. Sirius expects to hit break-even in 2005 and could be profitable in 2006.
Not everyone is sold on the concept, of course. Skeptics note that if Sirius and XM don't
reach break-even, both will collapse -- much as two other satellite-based marvels, the
Iridium and Globalstar global phone systems, did in the past few years. Consumer
awareness remains low.
The worries have kept XM and Sirius shares depressed and highly speculative. XM trades
for $3.75, way below its peak of 46 in 2000, while Sirius is at 75 cents, compared with a
high of 63 in 2000. The pair's combined market value is just $1.5 billion, 1/50th of the
$75 billion total market capitalization of the publicly traded radio stocks, led by industry
giant Clear Channel Communications. But if XM and Sirius can attract 10-to-20 million
subscribers during the next five years, their stocks almost certainly will surge.
While the rivals are both losing lots of money, Sirius is in worse shape. It's seeking to
complete a financial restructuring next month that would eliminate almost all its $700
million of debt and replace it with newly issued equity. If the plan fails, the company has
said it probably would seek a "pre-packaged" bankruptcy that is likely to wipe out
existing shareholders.
Nevertheless, Sirius's chief executive, Joe Clayton, sounds a bullish note. "We're starting
to build momentum," he says, adding that he's "confident" that the proposed financial
restructuring will be cleared by bondholders.
Both he and XM CEO Hugh Panero think satellite radio will hit a critical point when total
subscribers reach one million later this year. "When you hit a million, everyone you deal
with starts to perceive you in a different way and you are really beginning to deliver an
audience," Panero maintains.
XM, for its part, appears to have adequate capital
and, apparently, an abundance of confidence. "We
aim to be the HBO of audio programming," says
Panero. Interviewed at his company's Washington headquarters, he boasts that XM,
unlike Sirius, has consistently delivered on its financial and subscriber targets: "We're
a good horse on a muddy track."
Gary Parsons, XM's chairman, says he'd be disappointed if it fails to eventually reach
10 million subscribers. "This is a mass-appeal product," he says. "We don't want to
be pigeonholed as a satellite company. We're an audio entertainment company."
General Motors, XM's key partner and largest investor, with a 19% stake, has rolled
out XM radios as optional factory-installed equipment in 25 of its 57 car, light-truck
and sport-utility models in the 2003 model year, including the entire Cadillac line.
That figure will climb to 44 models for the coming 2004 model year, which starts in
the summer. It's possible GM will equip 800,000 2004s with satellite radio. The
GM-installed XM radio, built by Delphi, costs $325 and is bundled into the price of the
vehicle.
Honda, another sizable XM shareholder (it owns 8%), plans to include the system as
standard equipment in the 2004 Acura RL and as a factory-installed option in the
2004 Accord.
Sirius's partners, DaimlerChrysler, Ford Motor and BMW, aren't as far along in putting
Sirius radios in their vehicles. Daimler and BMW offer Sirius as a dealer-installed
option, meaning an auto buyer has to request that a dealer put in the radio. Ford
plans to offer Sirius radios later this year. Factory-installed Sirius radios aren't
expected to hit the market until the 2004 model year. Factory installation is
preferable to a dealer-installed option, because most car buyers prefer a system put
in at the factory and because it ensures that a selection of satellite radio-equipped
cars can be on a dealer's lot.
Sirius and XM also sell satellite radios through
consumer-electronics chains and car-audio
shops.
The automotive market for XM and Sirius is huge.
There are more than 200 million cars on U.S.
roads, and sales of new vehicles run at 16 million
annually. There also are three million long-haul
trucks and nearly four million large boats -- 22
feet or longer. The trucking market could be big
because truckers spend long stretches on the
road and need to stay awake; both XM and Sirius
have special trucker-oriented stations. Then there
are the 20 million Americans in rural areas that
get only five or fewer radio stations. That market
has been exploited successfully by satellite TV.
XM also offers an array of satellite radios for the home, called SkyFi, that sell for
$200 to $230 at major consumer-electronics chains. One is a highly rated boombox
from Delphi, which aims to ship 80,000 by midyear. A Barron's reporter found the
SkyFi's sound outstanding, as has Walter Mossberg, the finicky technology columnist
of our sister publication, The Wall Street Journal. Sirius plans to introduce home
radios later this year.
The big issue is whether Americans will pay for something they now get for free,
especially in a weak economy. Satellite-radio fans point out that the same argument
was made against cable TV in the 1980s. Now cable is in 70 million homes.
The commercial-radio industry's stance is that satellite radio will be only a niche
product because American drivers want "local" -- local sports, weather, traffic and
news, which satellite radio can't provide. Of course, there's nothing to stop a
motorist from going to AM/FM for the news, then switching back to a satellite
service.
Street analysts are ignoring the satellite threat to Clear Channel, Viacom and other
radio operators. But if satellite radio can attract five million to 10 million subscribers,
the radio stocks could suffer.
Clear Channel owns 3% of XM, but that won't be
enough of a hedge if satellite radio takes off and
meaningfully trims conventional stations'
audience.
And satellite radio has won over some listeners.
"We're very excited by what we've seen so far,"
says Rick Lee, vice president for satellite-radio
services at GM. Lee says recent GM surveys
show a 90% satisfaction rate among its
customers who chose XM, with 70% to 75%
saying they're likely to order satellite radio in
their next vehicles. Lee says interest from
dealers is building, and the world's biggest auto
maker expects to exceed its goal of putting XM in the 15% of 2003 GM vehicles that
can accommodate it. "XM could easily penetrate 50% of our production in five to
seven years," he adds.
Says Tom Keery, the dealer principal at Frost Motors, a Cadillac dealer in Boston:
"The initial response from buyers is, 'I get radio now. I don't need to spend $9.99 a
month.' But things change pretty quickly when we give them a demo ride."
Older Cadillac buyers like "Frank's Place," an XM Channel focused on Frank Sinatra,
Nat King Cole, Dinah Washington and other stars of the 1940s and 1950s. Younger
buyers of Cadillac's Escalade SUV gravitate toward rap, rock, soul or XM's reggae
station called "The Joint." Truckers partial to XM's only premium offering, Playboy
Radio, costing an extra $2.95 a month and featuring discussions by Playboy
Playmates about their sexual experiences, have formed a fraternity called Club 205,
based on its channel on the XM dial.
Both XM and Sirius have spent a lot of time and
money designing their musical programming,
including live performances, well-regarded DJs, and
exclusive talk shows. Sirius has a state-of-the-art
facility in Manhattan, and XM has a similar set-up in
Washington. Satellite-radio displays show the artist
and song, unlike AM/FM radio. Among the
misconceptions about satellite radio is that it just
rebroadcasts AM/FM stations.
Technologically, XM seems to have the edge, mainly
because its satellites are positioned in more
advantageous orbits. That's resulted in the faster
and cheaper development of "chip sets," the radio
receiver's guts, which turn digital signals beamed
from 22,000 miles above the earth into sound.
Both XM and Sirius supplement their satellites with
ground-based "repeaters" that retransmit the
signals in urban areas where buildings may cause
signal blockage.
Some big investors are bullish on the technology.
"We're wildly enthusiastic about XM, and we aren't known as wild-eyed bulls," says
Rick Barry, a partner at Eastbourne Capital, a San Rafael, Calif., investment manager
that owns more than 21 million XM shares. "There are very few investments where
the upside is so large if you get it right."
Barry says some Street analysts talk about the satellite radio's potential to generate
four million to five million subscribers, but he says the total could eventually be 40
million to 50 million, with XM dominating the market.
If XM hits 10 million in 2007, it could earn $500 million, or $1.50 a share. That could
support a $30 to $40 stock. A dream scenario could show XM with 30 million
subscribers in a decade, when it could earn $7 or more per share. Bear Stearns's
satellite analyst, Robert Peck, recently lifted his rating on XM to Peer Perform from
Underperform and his price target to $9 a share.
Even the bulls acknowledge that there are still big hurdles to overcome, but certainly
not as many as existed in
1997, when Barron's looked critically at Sirius, then called CD Radio. At that time,
with the stock at 17, bulls thought the company would start its service in 2000 and
earn $7 a share this year.
That obviously hasn't happened, and that's one reason there's significant short
interest in both Sirius and XM. The shorts focus on both companies' ugly financials
and argue that Sirius and XM are relying on growth forecasts that could prove to be
outlandish, much as those that went so terribly wrong for bankrupt telecom
operators such as Global Crossing.
There also are concerns about whether XM and Sirius will have to pay too much to
attract subscribers and whether they eventually will face high -- and worrisome --
levels of "churn," or the number of users who opt to discontinue the service, a huge
problem for the cellular phone industry.
XM had just $11 million in revenue in the first nine months of 2002 and a loss of
$355 million. Sirius only started generating revenue in the third quarter and lost
$334 million in the first nine months of the year. Both XM and Sirius have yet to
report full-year 2002 results.
Despite a tough environment for raising money, XM just completed a critical $475
million financing that produced $225 million of new cash for it through issuance of
convertible debt and stock. XM says it now has enough cash -- $300 million -- to
tide it over until late 2004, when it expects to be at the break-even point on a
cash-flow basis. Critical to the deal's success was the agreement by more than 90%
of the holders of $325 million of XM bonds to swap them for newly issued debt that
pays no interest until 2006.
One effect of the financing, which stretched out about $250 million of payments due
General Motors, was significant dilution to common shareholders. The radio service
now has about 215 million shares outstanding, compared with 90 million previously.
XM also has $800 million of debt and preferred stock outstanding.
XM is believed to have told investors that participated in its recent financing that it
can hit 1.3 million subscribers by year end, nearly three million by the end of 2004,
almost five million at the end of 2005 and 10 million by the end of 2007. XM
wouldn't comment on these numbers.
"XM is no Iridium," says George Haywood, a New York private investor with a
sizable stake in the company. "For starters, you have auto makers like Honda and
GM that have an incentive to make this work." GM is believed to get about $100 for
each radio installed and activated in its cars, plus a cut of the first year's service fee.
Haywood notes that the Federal Communications Commission won't grant any new
satellite-radio licenses until 2007, when XM and Sirius either will be so established as
to deter new entrants or be bankrupt. He says the duopoly means that satellite radio
is unlikely to face pricing wars like those of the cellular phone industry, in which six
national players compete so fiercely that nobody makes much money.
One potentially significant problem for XM is that its two Boeing satellites, "Rock" and
"Roll," are experiencing degradation of their solar power panels. That's prompted XM
to cut their projected useful life to 2008 from 2015. However, XM believes that it will
be able to launch additional satellites by the time the problem affects signal strength.
As noted, Sirius expects to complete a restructuring next month to eliminate its
$700 million of debt and $500 million of preferred stock, with holders getting new
stock. Sirius needs approval from 97% of its debtholders to move forward; it
recently said 79% had signed on.
As part of the deal, Oppenheimer funds will buy $150 million of new stock, while
Blackstone Group and Apollo Advisors, holders of Sirius preferred that's now
underwater, will each buy $25 million of equity. This will boost Sirius' cash total to
$300 million -- $75 million less than the company thinks it will need to survive until it
hits cash-flow break-even in 2005. Existing shareholders will face significant dilution
as Sirius grants nearly 900 million new shares, ballooning the total outstanding to
almost one billion, from 80 million.
Oppenheimer, Apollo and Blackstone wouldn't comment on Sirius.
The Sirius bull case is that it has more car companies on its team than XM, has a
lower enterprise value (equity market value plus debt minus cash) than its rival, and
should make up ground as Ford, DaimlerChrysler and BMW get behind satellite radio.
Sirius expects to have about 1.3 million subscribers in 2004, 2.9 million in 2005 and
4.9 million at the end of 2006.
Still, given its healthier outlook and head start, XM looks like the better bet.
Investors turning on one of its receivers in a few years could well be hearing the
sweet sound of success. |
