Satellite Radio Officials Cite Positive Trends

By Jimmy Schaeffler

Top investor relations officials from both Washington-based XM Satellite Radio [Nasdaq: XMSR] and New York-based Sirius Satellite Radio [Nasdaq: SIRI] recently offered their views about why both companies are gaining financial strength. Their views are summarized and paraphrased below. Increased subscriber totals offer clear evidence that both companies are on the rise, they said. XM Vice President and Treasurer Greg Cole offered his insights, while Sirius’ Vice President of Communications Jim Collins and Director of Investor Relations Cheryl Cramer represented their company.

Question: What is the cost breakdown and timing of hardware payments? Which company pays for the hardware and installation costs and when? In addition, who pays the subsidies needed to drop the price of the receiving equipment to $200 or less?

XM: The key point for XM is that any subsidy is paid at the manufacturing level. That avoids later mark-ups from a manufacturer that can raise the price of a consumer electronics item 200 percent to 300 percent. After that, retailers may raise the price by an additional 35 percent. XM believes that this “manufacturing level” subsidy payment accounts for savings of $3 per unit.

Sirius: Hardware payments as a part of subscriber acquisition costs (SAC) go to: a) the hardware manufacturers, b) the chipset manufacturers, c) the retail partners, and d) the original equipment manufacturers (OEMs). Sirius does not publicly disclose exact commission amounts or percentages paid to various parties. However, Sirius’ SAC in the first quarter of 2003 was $299 and that amount is expected to decline by about half to $150 by year-end. The company is paying many manufacturing-based subsidies rather than activation- based subsidies. The latter are to be avoided because they cost more, yet sometimes have to be done to build inventory. Of the $299 mentioned above, 35 percent has been paid out now to build up the “full pipeline” of Sirius product for future subscribers. For the typical $200 radio that is installed into a car, Sirius has a revenue sharing contract with the OEMs, plus warrant agreements with Daimler-Chrysler [NYSE: DCX] and Ford [NYSE: F], which are tied to the number of installations. Thus, there are no fixed payments to the OEMs. However, the company does have “fast-start payments to help retool the car factories.”

Q: What, if any, are the incentives for retailers and show floor salespeople?

XM: At stores like Circuit City [NYSE: CC] and Good Guys [Nasdaq: GGUY], XM encourages sales primarily by establishing and maintaining a “very reasonable price.” Additionally, there are some incentives offered to dealers. Commissions are paid for the sale of each unit and the salespeople receive a portion of the payment. XM’s entire economic stream is built around the idea of incentives to salespeople.

Sirius: The company offers “spiffs” (also known as incentives paid to retailers). No OEMs are paid spiffs, however. The idea of a spiff is that someone buys the service at a Circuit City, where the radio unit is installed. The dealer then receives its ‘”spiff” incentive payment.

Q: Is there any off-balance-sheet money owed to any other entities?

XM: The company’s latest 10-Q financial document for the period ended March 31 addresses these payments in footnotes number 6 and number 9. The 10-Q explains that XM currently has numerous notes, loans and mortgages outstanding, including sums owed to Boeing [NYSE: BA] and units of General Motors [NYSE: GM]. XM has two PowerPoint presentations available on its web site that relate to financial data aimed at shareholders.

Sirius: All obligations to Sirius partners were disclosed in the company’s latest 10-K for the quarter ended March 31. There are no fixed payments obligations owed to any OEMs.

Q: How high is the take up rate for cars where satellite radio service is offered? What is the churn, SAC (subscriber acquisition cost) and ARPU (average revenue per unit) right now?

XM: In GM cars where the radio is factory installed, the take up rate is greater than 70 percent. XM believes the potential actually is quite a bit higher. Other figures: (SAC) is $74 per unit; monthly churn is 1.34 percent (or 16 percent adjusted annually); ARPU is $9.34; and cost per gross add (CPGA) is $156. XM prefers the latter measurement, i.e., CPGA, as a purer indication of costs, because it is “fully loaded” and includes all promotional and marketing costs.

Sirius: It is too early to properly measure take up rates. When more factory installs are in place, then Sirius plans to do more take up rate measuring. Most installs today are coming from dealer recommendations. Churn today is at 1.5 percent monthly (or about 18 percent annually). SAC is at $299 per gross add for the first quarter of 2003; and ARPU is at $10.94, which includes all rebates (Note that Sirius charges $12.95/month, accounting for a slightly higher ARPU than XM, which charges $9.95/month.)

Q: Connectivity pulls consumers in every direction. How does XM and/or Sirius battle that?

XM: The company is doing a solid job via its a) delivery platform and b) great content service. It also has a “first mover advantage” that gives it significant momentum against all other competitors that offer connectivity to an automobile. This advantage has not been acquired cheaply by XM. For example, it takes a lot of time and money to get the XM radio factory-installed in so many vehicles today. However, XM believes that is the best way to get the service into people’s hands.

Sirius: Company officials believe that Sirius best combats competition in the auto industry by creating a unique service/product. Sirius highlights its mobility, quality, variety, and strong audio content, perhaps later buttressed by data and video. Rear-seat videos in cars are another market Sirius is interested in tapping.

Q: Are there any solid studies about the real size of the potential market out there today? What are XM and Sirius saying? How do XM and Sirius size the potential market?

XM: XM has done “lots of studies” in this area. The potential may be as high as “50 million autos,” based upon the concept of 208 million autos on U.S. roads today. XM likes to compare its base to that of direct broadcast satellite (DBS), which started with a potential target market of approximately 100 million U.S. TV households (TVHHs).

Sirius: The company has not yet conducted any third party studies. It believes that thus far the most objective views come from analysts and from Wall Street banks and investors. The company only needs two million subscribers to break even, and expects to do that in 2005. It is “not inconceivable to have 10 million to 15 million subscribers by 2007.” With 15 million to 17 million new trucks and cars produced yearly, that makes a great potential base, combined with the used car market. Like XM, Sirius points to the base of about 200 million registered U.S. autos. That potential market is double the size of that available for satellite TV.

Jimmy Schaeffler researches, analyzes and writes this monthly report. He is a subscription services senior analyst at The Carmel Group, a consultancy located in Carmel-by-the- Sea, Calif. (http://www.carmelgroup.com). The firm also publishes industry data books and the monthly newsletters DBS Investor and Satellite Radio Investor. The Carmel Group specializes in telecommunications (e.g., cable, satellite, wireless and telephony), as well as computers and media (especially advanced services such as HDTV, VOD, DVRs and iTV). He can be reached by e-mail, [email protected], or by phone, 831/643 2222.