Satellite Radio Orchestrates Growth

The enormous potential of satellite radio to gain broad consumer acceptance was exhibited again last week when both U.S. service providers took turns crowing about major accomplishments.

Washington-based XM Satellite Radio [Nasdaq: XMSR], the industry’s dominant provider, achieved record-setting subscriber growth during the fourth quarter that was capped earlier this month when the company topped the 1.5 million subscriber milestone. New York-based Sirius Satellite Radio [Nasdaq: SIRI] tried to share the spotlight by disclosing a marketing alliance with Ft. Worth, Tex.-based electronics retailer RadioShack [NYSE: RSH] and Littleton. Colo.-based satellite TV service EchoStar Communications [Nasdaq: DISH].

Those developments combined to give satellite radio further traction in the sector’s revved up drive to financial success.

XM once again displayed its growing sales momentum by beating the fourth-quarter guidance it previously had given to Wall Street. At the end of 2003, XM had amassed 1,360,228 subscribers, with record net subscriber additions of 430,580 coming in the fourth quarter, marking a 46 percent increase from the end of the third quarter.

The rapid subscriber growth at XM was buoyed by a “very successful” holiday shopping season. More than 100,000 new subscribers activated their units during the last seven days of December and 23,000 joined on Christmas Day itself, company officials said.

“With over 1.5 million subscribers today, the foundation is in place to grow XM’s business to 20 million subscribers by 2010,” said XM President and CEO Hugh Panero. XM has only “scratched the surface” of the potential market for satellite radio, he added.

Bob Peck, a satellite analyst with Bear Stearns, said XM had not previously forecasted that it would reach 20 million subscribers. The increased guidance also marked a 33.3 percent jump from his estimate that XM could top out at 15 million subscribers.

So far, XM has captured less than one percent of the 200 million U.S. vehicles on the road. With roughly 15 million to 16 million new vehicles manufactured in the United States each year, XM has a huge upside, he said.

XM’s financial performance during the fourth quarter showed further progress. The company boosted its fourth quarter revenue to $33.5 million, more than tripling the $9 million it amassed in the fourth quarter of 2002. The company’s full year 2003 revenue jumped to $91.8 million, rising 4.5 times above its 2002 revenue of $20.2 million. Its soaring subscriber growth largely accounted for the gains.

The reality is that XM continues to lose money as it spends heavily to entice new subscribers, but its bottom-line is improving. XM recorded EBITDA (earnings before interest, taxes, depreciation and amortization) losses of $95.5 million for the fourth quarter of 2003, after dropping $97.3 million for the same quarter of 2002. For full year 2003, XM reported an EBITDA loss of $318.9 million, compared to a loss of $318 million in 2002. The 2003 results were dragged down by the impact of de-leveraging activities that helped XM cut its debt and interest payments. Without those debt-reducing moves, XM’s EBITDA loss in 2003 would have shrunk to $294 million.

“We feel more confident than ever about making XM a huge commercial service as we head into 2004,” Panero told analysts and the media listening to his company’s conference call Thursday. “We have great momentum at retail and in the automotive sectors.”

Sirius Marketing

Second-to-market Sirius not only unveiled its new satellite entertainment alliance last week but also boosted its guidance to 1 million subscribers by year-end 2004, compared to the company’s prior guidance of 860,000.

Under the alliance, RadioShack stores and dealers and EchoStar DISH Network distributors will be marketing Sirius products and services by mid-2004. The alliance will increase the number of retail locations where Sirius’ products can be purchased from roughly 6,000 today to more than 20,000 by year-end 2004.

The alliance is “tremendous” for Sirius and should spur significant additional subscribers, said David Frear, Sirius’ executive vice president and chief financial officer. The company projects that it will generate more than 2 million subscribers for Sirius over the life of the multi-year alliance. The fruits should become apparent in the second half of this year.

Charlie Ergen, EchoStar’s chairman and CEO, said his company decided to form an alliance with Sirius, rather than invest directly in the satellite radio company at this time. He said EchoStar is eager to begin offering the satellite radio service to DISH Network’s subscribers. Subscribers to the DISH Network’s medium-tier programming package, America’s Top 120, will be given access to Sirius’ 61 music channels at no additional charge. Ergen said he hoped that subscribers to his least expensive service might be enticed to upgrade one level to obtain Sirius service. Sirius will replace the Muzak service that had been offered by EchoStar.

“This is a great example of a very natural and complementary partnership between three companies, Ergen said during a Feb. 12 conference call that included the CEOs of the three companies. “All three of us are going to do what we do best. We don’t have to change anything in our business plans. We will continue to focus on what we are doing. We each have our own roles to play.”

Each company has financial incentives to deliver sales for the others, Ergen said. “The more we sell, the better it is for all of us,” he said. “It is structured in a way that everybody has a lot to win by being aggressive here.”

The three-way alliance allows RadioShack to begin offering Sirius Satellite Radio, while maintaining its existing distribution of EchoStar’s DISH Network service. The alliance would give RadioShack customers one-stop shopping for their satellite entertainment needs. “With our engaged, knowledgeable sales associates and 7,000 points of distribution in every neighborhood in America, we’re in the unique position of being a market-maker for innovative technologies,” said Leonard Roberts, chairman and CEO of RadioShack.

“We can accelerate the adoption rates of new technology,” Roberts said. “CDMA wireless technology is a huge example. We made it accessible and understandable.”

RadioShack’s mission is to “demystify technology” in every neighborhood in the country, Roberts said. Satellite radio is the next new technology. However, the latest market research has found that satellite radio is still a mystery to the vast majority of people, he said.

“While satellite radio’s market potential is enormous, it is still basically untapped,” Roberts said. “In other words, it is a prime technology just waiting to be demystified. That is where RadioShack comes in, to demystify the technology and drive adoption rates.”

Joe Clayton, president and chief executive officer of Sirius, said, “RadioShack’s 35,000 sales personnel are well trained and will make the process of educating and selling to consumers easy.” In return, Sirius will help to add to the “buzz” of RadioShack stores. RadioShack helped satellite TV take flight and it will be a “major contributor to our success,” he said.

EchoStar, Sirius and RadioShack also announced that they would develop marketing strategies to promote their alliance, including possible innovative products and services.

Sirius cited the alliance as a reason for lifting its full year 2004 revenue guidance to more than $70 million, up from its previous estimate of more than $60 million. Sirius still expects to reach its cash flow breakeven point of 2 million subscribers by the end of 2005.

Sirius announced Jan. 28 that its subscriber numbers increased eight-fold in 2003 to reach 261,061.

“It is now clear that the satellite radio industry is taking off and Sirius is very much in the game,” Clayton said.

Once EchoStar customers hear Sirius’ commercial free music as part of the DISH Network TV service, many of them will want satellite radio in their vehicles, boats or wherever they go, Clayton said.

Another byproduct of the alliance should be reduced hardware costs for Sirius that would be achieved through economies of scale, Clayton said.

Sirius’ cash flow also should be helped because both EchoStar and RadioShack retailers know how to activate a subscription service immediately at the point of sale, Clayton said. Now, an activation lag occurs between the time a unit is purchased and when a user calls Sirius to begin his subscription.

The alliance also should produce marketing advantages for all three companies, as well as bring together strengths of the companies for the benefit of consumers, Clayton said. Those pluses include innovative technology, outstanding products and services, increased presence to reach consumers, and a track record for growth, he added

“This is a powerful combination,” Clayton said. “Together, we will drive awareness, availability and activations.”

In Ergen’s view, the “sky is the limit” for satellite radio. “The big untapped potential out there is going into cars that are already on the road, with an aftermarket product, Ergen said. “I think that RadioShack, the DISH Network, and our other independent retailers are best positioned to do that.”

EchoStar also might be able to cut its churn by offering Sirius music programming that consumers may not want to give up, Ergen said. –Paul Dykewicz

(Chance Patterson, XM Satellite Radio, 202/262-5213; Bob Peck, Bear Stearns, 212/272-6665; Jim Collins, Sirius Satellite Radio, 212/901-6422; Steve Caulk, EchoStar, 303/723- 2010; Charles Hodges, RadioShack, 817/415-3300)