Dollars And Sense: Satellite Radio Has Arrived!

Armand Musey

XM Radio re-ceivers became available in Dallas and Phoenix in September, the service is rolling out in the southwest in October, and should be available throughout the entire country by November in time for the holiday selling season. XM Radio is spending millions of dollars on advertising to promote the service. After the debacles of Iridium and Globalstar, the satellite industry desperately needs a strong win, and satellite radio could be it.

XM Radio offers listeners 101 channels of music, 38 of which are commercial free, and 62 channels of news and talk radio, plus one preview channel. We were able to demo XM Radio’s service in Dallas in early August and were highly impressed. We drove through the city’s business center with its tall obstructing buildings and the signal was never disrupted, delivering crystal clear audio from a number of music genres.

The real question now is, how many people are going subscribe? Consider this, before you can receive satellite radio’s signal, you will need to plunk down about $500 to $700 for a first-rate car stereo, and then the real kicker, you have to pay $9.99 a month to get the signal. Satellite radio’s detractors think that these services will have a hard time getting some people to pay $9.99 a month for radio.

This group also argues that even if satellite radio is successful at attracting subscribers it will not be economically successful. They point to the high cost of subscriber acquisitions, asserting that the equipment subsidies and retail commissions will outstrip subscriber revenues, citing as evidence the escalation of DBS subscriber acquisition costs. They also point to the potential for high levels of non-activations and customer churn.

Finally, both satellite radio companies will need a significant amount of financing before they become profitable. XM Radio had $330 million in cash and restricted investments at the end of the second quarter and Sirius had $440 million. We estimate this is enough to last XM Radio through the first quarter of 2002, and Sirius through the first quarter of 2003, given the latter’s slower rollout of its services. We believe both companies will need nearly $500 million in total financing over the next three years.

Satellite radio’s detractors are not an insignificant contingent. The “short interest” in XM Radio is currently 10 million shares. That means, of XM Radio’s 15 million outstanding shares, investors have borrowed two-thirds and sold them, betting the price of the stock will go down and they will be able to buy them back at a lower price. Almost all stocks have a “short interest,” but it is very rare for such a large percentage of a company’s shares to be short.

With strong support from the automobile companies we think satellite radio has the potential to be a broadly accepted consumer offering, but it is going to take some time to catch on. We are forecasting XM Radio and Sirius together to have 50,000 subscribers by year-end. However, we do not expect broad consumer awareness of satellite radio until at least the fall of 2002 and do not expect satellite radios to be widely specified in automobile line-ups until the early 2003 model year.

We also believe that satellite radio will achieve economic success. Satellite radio’s nationwide distribution capabilities give the two companies breakeven economics at relatively modest levels of market penetration, and allow them to develop high margins and generate significant amounts of free cash flow with more mature penetration. We are forecasting both XM Radio and Sirius to reach EBITDA breakeven in mid-2004 with roughly four million subscribers each, and believe that both companies should generate strong EBITDA growth thereafter.

We realize that we are among the optimists with regard to satellite radio’s prospects and that a lot of smart people disagree with us. It is hard for anyone to determine what people will and will not buy, and initial subscriber uptake is likely to offer only anecdotal evidence of eventual customer acceptance levels without the automobile OEM channel fully up and running. Maybe if the “shorts” on XM Radio and Sirius lived in rural America where radio service is limited there would be greater support for these companies’ prospects.

Armand Musey is the satellite communications analyst at Salomon Smith Barney (“SSB”). The foregoing article should not be considered as a recommendation with respect to any security. SSB and its affiliates may maintain a long or short position in, act as a market maker for, or purchase or sell a position in, securities of referenced entities and may also perform investment banking, advisory, or other services for any such entity.