XM Refuels With Needed Financing

Washington-based XM Satellite Radio [XMSR] is sacrificing a big portion of the ownership stake of its existing shareholders in a planned $450 million restructuring that will gain the company about two years worth of operating cash.

The deal stops well short of the severe dilution faced by the initial shareholders of rival Sirius Satellite Radio [SIRI] last September when a $1.2 billion recapitalization was announced that would leave those investors with just 8 percent of the New York-based company. XM’s existing shareholders still would control roughly 55 percent of the company, rather than 100 percent, due to newly issued shares that the latest round of investors would obtain in exchange for pumping money into the cash-hungry operation, Wall Street analysts estimated.

Without the new financing, XM only had enough cash on hand to last until the end of the first quarter of 2003. Its officials expressed optimism that the latest round of financing would carry it through cash flow breakeven.

XM CEO Hugh Panero said he hoped the announcement of the new financing package would help the company be valued by investors for its marketplace progress, business plan execution and future economic potential rather than as yet another satellite industry startup with heavy cash needs.

All necessary conditions and approvals of the financing should be met by the end of February, company officials said.

The financing would consist of $200 million in new funding from strategic and financial investors, along with $250 million in payment deferrals and related credit facilities from existing shareholder and partner, General Motors [GM].

The need for XM to dilute the stakes of its shareholders, despite the company meeting its subscriber growth estimates in 2002, shows the plight facing nearly all startup satellite companies. Financing either is prohibitive or exceptionally challenging to obtain on favorable terms for practically all but the most established operators.

In light of that daunting financing environment, Wall Street analysts generally seemed pleased the company announced a funding package but warned that significant marketplace hurdles remain.

Marc Nabi, a satellite analyst with Merrill Lynch, viewed XM’s gain of financial breathing room favorably. His reasoning includes that the proposed financing avoids an outright recapitalization, defers much of XM’s cash interest until 2006 and allays near-term financing concerns.

On the other hand, Merrill Lynch issued a note to investors Dec. 24 that expressed disappointment with the “significant dilution” faced by existing shareholders. Those investors now are left with less future economic benefit and “all the risk,” he added.

Karim Zia, a satellite and cable analyst with Deutsche Bank, suggested in a Dec. 30 research note that XM would need new financing by 2004. He explained that the company’s operations would not generate positive cash flow until the second half of 2006.

A financial shortfall of $425 million is expected between 2004 and the second quarter of 2006, based on the existing financial model that Deutsche Bank has for the company. However, XM initiated a significant cost cutting in fourth quarter 2002 and could scale back certain marketing efforts that would help to bridge that gap.

Despite the announced financing, a funding gap for XM of $450 million is expected by William Kidd, a satellite analyst at Lehman Brothers. His estimated gap includes a required $80 million refinancing in 2006.

A big concern for Kidd about XM is that the company’s rate of growth in new aftermarket subscribers has flattened during the past couple of quarters. If OEM (original equipment manufacturing) car sales show the same trend, XM’s business outlook would dim considerably, he added.

XM also pumped more than $150 million into promoting its service in its first five quarters of operation and may well need to scale back on that spending to conserve cash, Kidd said.

“The reality is that XM has spent an inordinate amount on marketing to hit its subscriber numbers,” Kidd said in an interview Thursday. “I think the product is struggling. I hope things go better in the OEM market.”

–Paul Dykewicz