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NEW KID ON THE BLOCK

Can Satellite Radio Do 'What Cable Did to Broadcast'?

By Christopher M. Wright

[This article was originally published in The Financial Manager, flagship publication of the Broadcast Cable Financial Management Association (August-September 2002)]

In the 1980’s, Psychology Today published a survey ranking the things that adults find most exciting in life. The results were astonishing, and not what you might think. At the top of the list (and better than you know what) was … music! Commercial radio is increasingly being criticized for its tired lifeless music, short play lists, and frequent commercial interruptions. Investors have pumped billions of dollars into satellite radio, hoping that the new medium’s adventurous commercial-free music channels, CD-quality sound, and nationwide signal coverage will woo people away from the AM-FM dial. This article discusses satellite radio‘s potential to do 'what cable did to broadcast’ and assesses the prospects for XM and Sirius, the two companies in the U.S. market.

'Cable For Your Car'

World music. Unsigned bands. New Age. Classical programming beyond Mozart and the Pops. This is what satellite radio offers - a hundred channels of specialized musical and informational programming in all. When you think about cable and satellite TV with the History Channel, Biography, and the Food Network, you get a sense of dé jàs vu all over again.

“Cable and satellite television have taken significant audience share away from the broadcast networks with high-quality niche programming,” says Mickey Alpert, President of Alpert & Associates, a Washington communications consulting firm. “Consumers have demonstrated that they want more choice and will pay for this convenience. They want more diverse programming than what ABC, CBS, and NBC now offer them,” Alpert says.

Jim Collins, VP of Corporate Communications for satellite radio company Sirius, agrees “the main issue is choice.” Sirius offers 60 commercial-free specialized music channels, plus 40 news, sports, information, and talk channels. (Some of the non-music channels are rebroadcast from well-regarded sources like the BBC, CNBC, CNN, and NPR, and thus some have commercials.) Sirius figures it carries twice the musical variety now available in the nation’s most diverse media market (New York). Sirius has channels for nearly every specialized musical taste, including 5 channels for Latin music alone. Its DJ’s are well-known and have studied their genres for years. Sometimes celebrity guest DJ’s are brought in. The listener experience on Sirius is further enhanced by interviews and live performances by both well-known and new artists, something XM also does. Tony Bennett, Dolly Parton, Brian McKnight and the rock group Semisonic are some of the artists who have appeared live on Sirius.

“I’m hooked on satellite radio,” Alpert says. There is always something he wants to hear on XM. He likes the fact that his favorite channels are free of commercial interruptions and the way the announcers take you back in time on the nostalgia music channels by playing old news and movie sound clips. Sometimes, he and his wife drive the long way home because they’re enjoying what they’re hearing on XM.

Sirius is different from XM in two important regards, Collins says. “The fact that all of our music channels are commercial-free is a big difference, as far as we’re concerned,” he says. Sirius chose the commercial-free route, supporting the strategy with a higher monthly subscription fee ($12.95 versus $9.95 for XM). Sirius also has a leg up over XM, Collins feels, because Sirius is exclusively partnered with DaimlerChrysler, Ford and BMW which together hold a substantially higher share of the new car market than XM’s only exclusive partner GM. GM has invested $120 million in XM. DaimlerChrysler and Ford combined have invested about the same amount in Sirius.

You’re Not From Around Here

Radio is changing and entrenched interests will either adapt or go out of business, Alpert says, drawing parallels to the way the TV broadcast networks had to adapt to cable and independent programming. “You can’t sit still in this environment of technological innovation,” he says. He remembers giving a speech to the National Association of Broadcasters warning them against championing the status quo. Those that took stakes in new media and embraced the new environment did comparatively well. ABC owns ESPN among other cable channels and is part of Disney. CBS, which languished as an independent entity, is now part of Viacom which owns substantial cable interests.

Alpert cites Clear Channel, which owns an 11.1% equity stake in XM, as an example of a radio company doing exactly the right thing in the new environment. Clear Channel has acquired many FM stations and is sometimes portrayed as a villain, the entity most responsible for killing FM radio with short play lists and 'attack of the clone' programming from a central location. “They’re not the bad guy,” Alpert says. “They’re the smart guy” for investing in a new medium which poses a potential threat to their existing business. “The whole nature of the radio industry is changing and the savvy guys will change with it.”

A Roll of the Dice

If XM and Sirius are going to do 'what cable did to broadcast', they have to survive the start-up phase and get to profitability.

It is commonly reported that XM and Sirius each need about 4 million subscribers to break even. Nobody really knows how many subscribers will sign up for satellite radio. As an investment proposition, satellite radio is for now the quintessential 'speculative gamble for risk capital'. These are start-up companies in a newly created market which may or may not be viable. Each company has already spent well over a billion dollars and the first revenues are just now trickling in.

There have been warnings from auditors about long-term viability, the resignation of a CFO, and 90 percent drops in share prices. Currently, the companies are experiencing the high cash burn rates and widening losses typical of start-ups.

Sound familiar? The parallels are enough to make anyone who lost money in the Internet bubble break out in a cold sweat.

In May, Sirius posted a net loss of $90.1 million ($1.22 per share) for the first quarter, versus a loss of $64.4 million ($1.34 per share) a year earlier. Revenue was $33,000 compared with no revenue in the same quarter last year.

XM ended its most recent quarter with 76,242 subscribers, revenue of $1.8 million and a loss to common shareholders of $117.7 million, up from a loss of $42.7 million in the year-ago quarter.

XM’s EBITDA loss was $75.9 million. EBITDA has been described by one wag as 'earnings before the bad stuff'. The bad stuff includes fixed interest payments on long term debt. Both companies have sizeable debt loads. By crunching numbers the companies provided to the SEC, one arrives at a Long Term Debt as a Percent of Capitalization for Sirius of 65% in 2001, compared to 62% a year earlier. XM’s long term debt load is relatively lighter - 31% debt to capital in 2001, up from 21% the year before. Sirius has higher fixed interest payments - $90 million in 2001 versus $18 million for XM the same year. Finance texts commonly recite that high fixed interest payments render firms vulnerable to economic downturns.

[UPDATE June 2003 - Sirius recapitalized, eliminating 91 percent of its debt in exchange for common shares.]

Both companies currently have enough cash to last about a year. Neither company expects to be cash-flow positive before then, so new capital infusions are likely, presenting current shareholders with dilution risk. Both companies have already been back to the capital markets with secondary offerings.

Will the New Kid Win Acceptance?

The potential is huge. In the U.S., there are over 200 million vehicles on the road, 115 million commuters, 22 million Americans who can count the number of radio stations they get on one hand, and 17 million new car radios sold annually - plus the home market. Several observers expect that satellite radio will eventually attract 20-30 million subscribers.

Alpert agrees with these estimates, assuming the companies continue to operate efficiently, maintain quality programming, and, when necessary, add enough ground repeaters to achieve good signal coverage. “I think satellite radio will be big,” he says. One reason, he says, is that high-quality satellite radios are being offered as standard or optional equipment in new cars. “It won’t be long before we start seeing the first year of service thrown in for 'free'” (included in the car’s purchase price), Alpert says. This would effectively remove the high get-started cost as a barrier to market formation (a satellite receiver, antenna and installation can run into the hundreds of dollars). DBS (direct broadcast satellite television), which is not even 10 years old, has 17 million subscribers without this built-in boost, Alpert notes.

Despite the optimistic forecasts, some question marks still hang over the industry. Regarding the potential size of the market, some observers don’t think satellite radio will make it because subscribers can’t get local traffic or weather. Others don’t believe people are as fed up with commercial radio as defectors to satellite TV were with their cable operators. There have been reports of spotty reception due to tall buildings, trucks in the next lane, and other obstructions. Wireless companies have complained to the FCC that satellite radio is interfering with their signals. The power supplies in XM’s satellites are being depleted more rapidly than anticipated. Meanwhile, commercial radio is not standing still - digital transmission is in the works to improve sound quality and stream information like artist name and song title alongside the audio.

Alpert and Collins both predict that satellite radio technology will advance, giving rise to enhanced services (and differential pricing) in the future. Just as DBS put hard drives in TV set-top boxes, next-generation satellite radio equipment will enable listeners to download entire albums, Alpert predicts.

Both also expect satellite radio to become an integral part of automotive 'telematics' systems, like GM’s OnStar, which provide navigation, use GPS to locate stolen cars, and send alerts when airbags deploy. Under the terms of its investment, GM has the right to use some of XM’s bandwidth to communicate with customers directly. GM could use XM’s signal to send maintenance reminders, leasing offers, recall notices, or even special programming like audio books or auto tours.

Alpert, for one, believes in satellite radio’s potential. “If you invest in both companies today at current market prices and leave it alone, you’ll be a very happy individual at the end of five years,” he says.

For More Information:

Sirius (NasdaqNM: SIRI) - www.siriusradio.com

XM (NasdaqNM: XMSR) - www.xmradio.com

A third company, WorldSpace, operates in Asia, Africa, and soon Latin America, emphasizing the delivery of information and educational programming to the developing world using cheap battery-powered receivers - www.worldspace.com.
[n.b. - WorldSpace went public 8/4/05 amid controversy]

Christopher M. Wright is a freelance writer based in Washington, D.C.

His investment club owns shares in Ford.

Consultant Mickey Alpert does not have XM or Sirius as clients but owns stock in them and in certain other companies mentioned in this article.

The information presented in this article in no way constitutes a recommendation to buy or sell securities.

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