XM Satellite Radio [Nasdaq: XMSR] has turned meeting expectations into a habit that is welcomed by Wall Street.

The Washington-based satellite radio services company did it again last week when it posted 483,000 subscribers at the end of the first quarter. This reflects a net gain of 135,000 over the previous quarter, surpassing the company’s guidance of 130,000. As a result, XM is building a valuable reputation for delivering on promises to investors.

The biggest disappointments thus far have been technical problems with its two in-orbit satellites and a financial restructuring that diluted the value of the company’s shares.

Wall Street analysts are rewarding the company’s management with upbeat research reports that were issued after XM’s conference call late last month to update analysts on its progress in gaining new subscribers.

Bob Peck, Bear Stearns’ satellite analyst, is bullish on the company. His confidence was boosted when XM topped his estimate of 120,000 net new subscribers for the first quarter. Peck poured over the 10-K that XM filed last week with the Securities and Exchange Commission and said he found no “surprises.”

XM also received a good review from Deutsche Bank Securities analyst Karim Zia, who last week raised his stock price target for the company. At the same time, Zia cut his “buy” rating on the stock to “hold” because of a recent 50 percent surge in XM’s stock price.

XM’s $86.4 million EBITDA (earnings before interest, taxes and depreciation) loss in the fourth quarter was in line with expectations, Zia wrote to his clients. Subscriber acquisition costs (SAC) during the same quarter of $94 were lower than the $123 predicted by Deutsche Bank and the $129 estimated by Bear Stearns.

A new performance metric – cost per gross add (CPGA) – was introduced by XM management that takes into account costs that SAC excludes. XM’s CPGA hit $240 at year-end and is expected to drop significantly during the next couple of years, according to Peck. GPGA differs from SAC by including the total costs of gaining new subscribers, including advertising and marketing, not just manufacturing subsidies and activation commissions paid by XM.

Chance Patterson, XM’s vice president of corporate affairs, said the CPGA metric was developed by XM after looking at other subscription-based businesses. The intent is to create a more meaningful way for the costs involved in obtaining new subscribers to be assessed, he said.

CPGA does not include some costs, according to Zia. The metric omits the expense of marketing staff and subscriber communication costs included under retention and support, and the amortization of guaranteed payments to parent General Motors, he explained.

For full-year 2003, XM is forecasting 1.2 million subscribers, compared to an estimate of 1.1 million by both Deutsche Bank and Bear Stearns.

Show Me The Money

Deutsche Bank still is forecasting that XM will need additional funding to achieve free cash flow break even, Zia explained. Further financing of $240 million is required to help the company reach break even by mid- to late-2004, he concluded.

XM did succeed in raising $475 million in additional funding in January. The financing consisted of $225 million in new funds from strategic and financial investors and $250 million in payment deferrals and related credit facilities from GM.

As part of the financial restructuring, XM was able to retire its 14 percent senior secured notes due 2010. In return, the note holders received a package of cash and new securities that include new notes, plus warrants to purchase common stock. More than $300 million, or roughly 92 percent of the original notes, were tendered, and 25,514,960 warrants, exercisable at $3.18 per share, were issued to the note holders.

Mickey Alpert, a satellite broadcasting consultant who heads Washington-based Alpert & Associates, said it is “very positive” for the industry that both XM and rival Sirius Satellite Radio [Nasdaq: SIRI] were able to secure additional financing, albeit at significant dilution to the common shareholders.

XM’s new funding, improved business model and support from automobile manufacturers give the company strong momentum, Peck wrote to his clients in a research note. The sale of XM as a factory-installed option on new vehicles is a huge opportunity for the satellite radio services provider, he said, adding that the prospects will only grow as the number of new vehicle models offering XM expands.

GM is expected to offer XM as an option or as standard equipment on nearly all of its models in the future. While XM currently is available as factory-installed equipment on 25 vehicle models, 44 of GM’s 57 models will carry XM at the beginning of the 2004 model year.

XM is expecting that 60 percent of its net new subscribers will come from aftermarket retail sales this year, while the remaining 40 percent will come from original equipment (OEM) sales. Bear Stearns concurs with that projection, while Deutsche Bank expects the reverse, with OEM sales leading the way with a 60 percent share. XM management expects long-term that half of net subscriber additions will come from the OEM market, while aftermarket retail sales will account for the other half.

In Peck’s view, the number of XM subscribers estimated for 2003 is tied directly to OEM sales for the 2003 model year. Roughly 70 percent to 75 percent of the estimated 400,000 new GM vehicles that will offer factory-installed XM units in the 2003 model year are projected to be activated, according to industry estimates.

XM amassed 50,000 subscribers through GM OEM sales by year-end; that total fell short of projections that ranged between 60,000 and 70,000. The shortfall was due to under- estimating the training necessary to support GM’s network of 7,500 dealerships.

Additional OEM sales in 2003 will come from distribution through Honda, Toyota, Nissan, Volkswagen and Isuzu.

Boom Box Bounce

XM also should gain a lift from expanded distribution of Delphi-built portable SKYFi plug ‘n’ play XM satellite radio units to aftermarket retailers. The next-generation SKYFi receiver retails for $229.99 (MSRP). It has a large display, direct channel entry, the ability to preview and search XM channels by artists and song titles and 20 channel presets. The compact receiver, along with vehicle and home accessory kits, arrived at major retail outlets in October.

Roughly 80,000 “Boom Box” SKYFi units will be shipped by Delphi to aftermarket retailers during the first half of 2003. Retail distribution also will include all 2,800 Wal-Mart stores in the United States to enable consumers in smaller markets easier access to the service.

XM plans other product rollouts this year that should be enticing to potential customers, Patterson said. “While we do expect the SKYFi unit to continue to be a strong seller in the coming months, there will be other new products available that will further grow our sales throughout the rest of this year.”

Another marketing plus for XM is a new “family plan” subscription program. That plan would allow a family that has one member paying the standard $9.99 a month for basic service to receive a reduced monthly price of $6.99 for each additional subscription.

The negative impact of the discount on XM’s average revenue per unit (ARPU) is “fairly immaterial,” Peck observed. “The more important issue is that the discount makes sense for a product like XM, particularly as it tries to build higher levels of subscriber satisfaction and entrench itself with its subscriber base.”

XM and Sirius are both making strides in signing up car rental companies to offer their radio services.

XM has taken the lead in subscriber activations, initial OEM offerings and the development of radios that work outside the car, Alpert said. However, the market is large enough and the service is attractive enough for both companies to prosper in the long run, he added. –Paul Dykewicz

(Bob Peck, Bear Stearns, 212/272-6665; Karim Zia, Deutsche Bank, 212/469-7591; Chance Patterson, XM Satellite Radio, 202/380-4318; Mickey Alpert, Alpert & Associates, 202/872-8605)