Satellite Radio's Shaky Stairway to Heaven


By Amey Stone At a time when consumers just don't seem that interested in many of the technological innovations being pushed at them (such as broadband Internet access or digital television, to name two), it's worth taking note when a new product shows early signs of being more popular than expected. That's especially true when it may hold hidden gems for investors. One such case is satellite radio, which charges users monthly fees to receive digital broadcasts of up to 100 stations, including commercial-free music.

XM Satellite Radio (XMSR), the first of two satellite-radio companies out of the gate, announced on Apr. 1 that it has signed up 76,000 customers for its $10-a-month service, which debuted last November. Analysts had projected 70,000 by the end of the first quarter. "We're thrilled about how far we've come in a relatively short period of time," says company spokesman Chance Patterson.

Sirius Satellite Radio (SIRI), which debuted its $13-a-month service in four cities in mid-February, hasn't released any membership numbers. But investors cheered on Mar. 27 when Sirius said it would finish rolling out its national service by July 1, a month earlier than expected. "Our test markets have gone so well that we were able to accelerate the national launch," says Mindy Kramer, a spokesperson.

POSITIVE SIGNS. Also important to investors: Sirius announced that it was able to renegotiate its credit terms with Lehman Brothers, basically getting an extension on meeting membership requirements that were set before Sirius suffered about a year's worth of delays launching its service.

Marketed for use in cars, Sirius' service requires replacing your car radio with a new $300 unit and joining one of the company's membership rolls. Tweeter Home Entertainment Group (TWTR), one of many audio-equipment retailers selling radios for both services, recently pointed to early positive signs for the fledgling industry.

Tweeter announced on Apr. 4 that satellite-ready radios amounted to 30% of its first-quarter sales of car radios (or head units, as they're called in the industry). "It has really revitalized the whole head-unit business," says Tweeter spokesperson Anne-Marie Boucher. "It's catching on quickly."

SLAMMED STOCKS. It's far too early to proclaim satellite radio a hit with consumers -- or a solid investment choice. As the Nasdaq has slid and risks have mounted for debt-laden startups, each company has seen its stock plummet. Sirius, because of its execution problems, has taken the worst drubbing. It trades at just $5 a share, from a high of $60 in early 2000.

XM traded up to $45 in 2000 and is now at $13. But if satellite radio can penetrate 5% to 10% of the driving public (about 180 million drivers), these stocks will have a huge upside, says Eric Green, portfolio manager at Penn Capital, which owns shares in both companies.

Satellite radio has many more hurdles to jump before it gets there. William Kidd, an analyst at Lehman Brothers, rates both stocks a strong buy, but notes that "while there is a lot of potential upside in these names, they are immensely speculative." He's projecting both services will hit break even (as measured by EBITDA: earnings before interest, taxes, depreciation, and amortization, a key cash-flow barometer) in early 2005, when they should each have 3 million to 4 million customers.

"VERY SMALL WINDOW." Kidd isn't looking for reported profits until 2006, when they should have 6 million to 7 million subscribers each. In the meantime, the companies will need $500 million to $600 million more in financing to keep going.

Here's the rub for investors: If XM and Sirius can't prove there's strong customer demand for satellite radio service by the third or fourth quarter of this year, they won't get the additional capital. To impress Wall Street, they will need to have 500,000 subscribers combined by the end of 2002, which would require a major acceleration in new orders in the second half of this year, says Kidd. "These companies have a very small window of opportunity," he says.

Analysts expect membership numbers to ramp up once the radios start being installed in new cars. General Motors (GM), which has an exclusive deal with XM, has already started building them into two Cadillac models and will add about two dozen more models by yearend.

TAKE YOUR CHOICE. Ford (F), DaimlerChrysler (DCX), and BMW, which are exclusive partners of Sirius, are likely to announce factory installations in the near future, say analysts. Volkswagen and Nissan at the end of March said they would equip cars for both services, allowing customers to choose between the two.

The carmakers' continued backing is an encouraging sign, say analysts, since it indicates the services work well. Because its launch was delayed due to technical problems, Sirius in particular still faces quality questions, but it's now doing its best to make them a thing of the past. "There are no issues," says Kramer.

Still, XM is clearly ahead of Sirius in proving itself, which could make it the safer stock of the two. It also has a slightly different business model, including selling a limited amount of advertising, which it expects eventually to provide half its revenues.

"WEAK COMPETITION." Sirius may have more upside, analysts say. With no advertising on its music stations, it's billing itself as the "premium" service. Another reason for analysts' optimism is that Sirius last November got a new management team, including CEO Joe Clayton, who's credited with expediting the roll-out.

John Stone, an analyst with Ladenburg Thalmann & Co., has a $13-a-share price target for Sirius and $22 for XM. "In cars, the only competition is free radio -- and frankly we think that's pretty weak competition," he says.

For now, it seems like either both services will make it or neither will. A user of the service himself, Green is confident that users will love -- and pay for -- satellite radio, even if he's wringing his hands now over whether the capital markets will provide the companies with additional funding. "It's sad to say, but a lot hinges on the Nasdaq and investors' ability to take risk," he says. "It just depends on the patience of the financial markets at this point."

Investors should find it encouraging that satellite radio works, its first customers like it, and carmakers are putting it in their cars. Investors who love risk and are confident that the Nasdaq is going to rebound might want to get in now. Everyone else, well, stay tuned. Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column


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