Dollars and Sense: The Sounds Of Satellite Radio
by Armand Musey
In a market that has been nothing short of cruel to concept-based companies, share prices of satellite radio initiatives have fallen significantly. As of the close on January 4th, Sirius Satellite Radio (SIRI) was down 38 percent from its third quarter closing price of $52 7/8, and XM Satellite Radio (XMSR) was down a whopping 59 percent from its third quarter closing price of $43 1/16. We believe the worst is over. With Sirius previewing its service and XM having showcased its satellite radio receivers at the 2001 International Consumer Electronics Show in Las Vegas last month, the countdown to commercial launch of satellite radio has begun. Against the backdrop of stabilization in the broader market, we expect satellite radio share prices to rise with announcements relating to the upcoming rollout of service.
Sirius and XM have come a long way since we published our first Satellite Radio Industry Overview in October 1999. For one, both companies have managed to raise a significant amount of capital from investors. Through a combination of private placements, borrowing, and IPOs, Sirius has raised $1.24 billion and XM has raised $1.1 billion, sufficient funds to see each through commercial launch. Both companies have also managed to obtain important installation agreements from the largest automobile manufacturers, development agreements from most radio manufacturers and distribution agreements from many aftermarket radio retailers. Sirius has its complete satellite constellation in orbit and recently announced that all systems were go. XM is set to launch its first satellite, “Roll,” at the end of this month, and its second, “Rock,” is scheduled for April 2001.
Both Sirius and XM have committed to commercial launches of their services in the latter half of the year. Sirius is planning a full-scale commercial launch after it completes a three-month beta test of its broadcasting system to receivers distributed to a limited number of users. In a slightly bolder step, XM has announced it will go live as soon as it gets Rock and Roll in orbit and its broadcasting system up and running. We believe aftermarket receiver sales will be a crucial indicator of market acceptance during the initial year of these services, as this is where the early adopters will buy receivers. However, the endgame will clearly be won in the automobile OEM (original equipment manufacturer) market, as building-out an installed base will be the key to gaining subscribers.
Given the limited nature of radio programming in many regions of the country, we are highly optimistic that significant demand exists for satellite radio. However, we acknowledge there is a great deal of uncertainty surrounding this assertion. The idea of paying $9.95 a month to listen to the radio remains a foreign concept to a large percentage of the population, and the analogy of pay-TV is not entirely applicable either as regular radio’s current programming offering is far more diverse in urban areas than that of broadcast television in the 1970s. Consulting and marketing studies indicate that satellite radio will take-off more quickly than any other consumer application. These same consulting and marketing studies predicted satellite telephony will also be a homerun.
Ultimately, the success of satellite radio will be determined by the quality of the programming that these companies can deliver, and the strength with which receivers are marketed. In regard to programming, there is little certainty we can offer investors. If Sirius and XM can, in fact, deliver superior programming, we are confident they will be able to sell satellite radio receivers in quantity.
Due to the level of uncertainty surrounding exact satellite radio demand, we believe it is prudent to be conservative in our forecasts for subscriber growth and acquisition costs, monthly revenues per user, churn rates and potential advertising revenue. We are projecting 250,000 subscribers by year-end and ramping to 23 million subscribers by 2009, or roughly eight percent of the population. We believe subscriber acquisition costs will be in the $150 range at the time of initial launch, stabilizing at $90 by 2005 as the largest component of acquisition cost, the chipset subsidy, declines due to mass production. We assume no change in initial revenues per user of $9.95 and a churn rate of 4 percent per quarter, which is slightly higher than DBS. Finally, our advertising model significantly undercuts both companies’ internal projects. Even with these very conservative assumptions, our analysis shows that tremendous value exists in satellite radio.
Throughout the year, we believe investors will look for positive news regarding the following developments (1) availability and distribution of the satellite radio chipsets to radio manufacturers, (2) aftermarket availability and early market acceptance of satellite radios, (3) a ramp-up of OEM installations, (4) and the quality of both services’ initial programming. If both companies are able to successfully execute on these items, we expect a significant upside to current share prices. We believe shares of both Sirius and XM are significantly undervalued and recommend them with a buy rating to investors with a high tolerance for volatility.
Armand Musey, CFA is a satellite communications analyst at Banc of America Securities LLC (BAS) . The foregoing article does not necessarily reflect the views of the Via Satellite editors and should not be considered as a recommendation with respect to any security. BAS 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.