How Sirius Is Writing Stern’s Check

Conventional wisdom is that New York City-based Sirius Satellite Radio [SIRI] was savvy to hire shock jock Howard Stern and his entourage for the princely sum of $100 million annually for five years, starting in 2006. His crew will bring their off-color radio show and possibly several million fans to the second-to-market U.S. satellite-radio company that recently topped the 600,000-customer mark. My view is that Sirius management may have showed its greatest wisdom by almost simultaneously raising $321 million to avoid the risk of running short of money to cover that whopping expense.

The biggest mistake I have seen in the satellite industry during my more than 10 years of covering it is when startup businesses fail to put the interests of shareholders first. Instead, they can make unwise use of investment dollars and they can become enamored with chasing dreams before obtaining the needed financial resources.

A perfect example of the high-risk, spectacular failure business approach occurred when mobile-satellite phone services collectively squandered close to $10 billion in the late 1990s and early 2000s. Those companies lacked proper financial discipline and realistic business plans. The demand for such services was grossly overestimated. The realization that cellular technology had become too cost-effective and inexpensive for satellite voice services to compete against was much too slow to be realized. In hindsight, Iridium, Globalstar and ICO were interesting ideas that should have been abandoned early when market conditions became unfavorable. Whenever dreams cloud the thinking of management, financial disaster is a possibility.

The bold bets Sirius President and CEO Joseph Clayton made by committing $720 million to obtain attention-grabbing programming through two big deals so far this year is worth a closer look. Let there be no mistake that Sirius offers a much better business proposition than any of the mobile-satellite services that flopped. However, Sirius could be criticized for agreeing to commit $500 million to Stern as well as $220 million to the National Football League in programming rights agreements.

Research reports sent to me by more than half dozen Wall Street satellite analysts within a day of the Stern announcement identified a potential funding gap Stern’s salary might create for Sirius. The company moved quickly to raise additional capital and, within one week, closed an offering that totaling $321 million. Roughly $230 million would take the form of 3?-percent Convertible Notes due 2011, while the other $101 million would come from the sale of 25 million shares of new shares of Sirius common stock.

The ability to raise more than $300 million in capital is a “testament” to the confidence the investment community has in Sirius as satellite radio builds subscriber momentum, Clayton said. Both Sirius and Washington, D.C.-based rival XM Satellite Radio [XMSR] are introducing next-generation products in the marketplace, more dealer and factory programs from their automotive partners, and additional programming.

On the other hand, it is quite possible Sirius paid too much for the NFL rights and for Stern. It remains to be seen how compelling listening to all the NFL games on the radio will be when so many of them are on television each weekend. Stern was eager to avoid fines from the Federal Communi-cations Commission (FCC) for his racy broadcasts, so did Sirius really need to pay $100 million a year to outbid XM for his services?

Jim Collins, Sirius’s vice president of corporate communications, told me last week that his company had $600 million in funding before last week’s offering. With its capital position now at $920 million, he said Sirius is the best funded of the two satellite radio companies.

However, more than half of that money will be needed to pay off Stern’s contract. Another $220 million is committed to the NFL. Several analysts expect the Stern deal to require more than the 1 million subscribers the company estimates Sirius will need to cover the $500 million cost. Sean Butson, satellite radio analyst at Baltimore-based Legg Mason, is possibly the most bearish. He is forecasting that Sirius will need Stern to attract 2.7 million subscribers to cover the Stern contract. If Stern announces he will sign elsewhere well before his pact with Sirius expires, the company risks the potential loss of those who became subscribers to hear him. By then, Sirius should have been able to win the loyalty of the vast majority of those subscribers, Collins said.

Whether Sirius is paying too much or not for its programming is less important than its shrewd move of raising the money needed to cover those costs. As long as Sirius has the financial wherewithal to fund its operations, it should have time to recover if it turns out to have overpaid for its programming.