Wednesday, May 10, 2006

Satellite Radio As A Sector

May 10, 2006

Investors in satellite radio have had a frustrating year in 2006. Big news, big content, and tons of subscribers have had little effect on the price per share of Sirius and XM. Many people are asking a simple question.


There can be many reasons, but in the end it boils down to a fundamental switch in what is driving the price of these stocks. Investors are now looking at the financial metrics of these companies more than ever, and are likely wondering when profitability will come.

Sirius and XM are in a business that had tremendous start-up costs. They both are in a business that when launched was unproven. Satellites were launched, deals were struck, and subscribers began to roll in. So did expenses.

investors are now less geared towards impressive pieces of hardware and great subscriber numbers. They want to see financial metrics that illustrate that the satellite radio companies will be a success.


The good news is that day appears to be on the horizon for both companies. Sirius is anticipating positive Free Cash flow as early as Q4 2006 and counterpart XM is anticipating that status in 2007. Q1 numbers from the respective companies showed a glimmer of better financial days, but it appears that it was not yet enough to set the stock prices on an upward trend. This has many people asking one simple question.


Sirius and XM have both had some issues to contend with that are acting as a cloud over each equity. Because these equities trade in similar patterns, the cloud can at time seem all encompassing. Shortly after Stern arrived at Sirius, CBS Radio filed a lawsuit. This represented the beginnings of a cloud. Sirius then absorbed the full impact of the Howard Stern shares in their Q1 financials. People were well aware of that aspect of the loss, but that news is tough to jump for joy about (at least in Q1 - going forward Sirius investors do not have that happening again). Sirius then had the CGC complain to the FCC about FM modulators on many Sirius units. For their part, XM had a Board member resign, and has had 9 law firms involved in a Class Action lawsuit against XM. Further, there is GM's woes, as well as GM supplier Delphi which is currently in bankruptcy. In the midst of this XM also has investigations from the FCC and FTC ongoing regarding the SKYFI 2 and marketing practices respectively. Then we have the unknowns surrounding the WCS spectrum that XM is acquiring, and what business plan/model XM will employ. These are substantial clouds and/or questions that weigh on the sector.


To some, the issues are enough to keep them on the sidelines. To others the issues represent a reason to go short, and still others see these equities as oversold, and have made an entry into the stocks. This kind of "market confusion" never plays particularly well on an equity.


Lets look at this one issue at a time.

1. The CBS Lawsuit - The news of the suit broke, and there were instantly hundreds of opinions on the subject. The suit brought endless fodder to the message boards, and clearly became an event that people were keeping an eye on. The good news is that the suit is close to being settled, and that cloud will soon disappear.

2. The Loss Attributable To the Stern Shares - This had the potential to have a major impact on Sirius, and thus the sector. Thankfully, Sirius beat the streets estimates, and Sirius performed well on the day the financials were released. The issue is now behind Sirius, and Q2 is shaping up to have nice potential. It is possible that Sirius could show a lower Year Over Year Q2 loss. This would work wonders on the stock and outlook in our opinion.

3. The CGC Complaint Regarding FM Modulators - This issue is still unclear, but may not be as bad as many think. There is interpretation of the regulations at play, and frankly, the FCC is not very likely to take what would be drastic action in our opinion. A small fine may be issued, but even that may be unlikely. My factory installed car stereo has 87.7 and 87.9 available on it, and those channels do receive radio signals in the Boston market. The new Sportster 4 avoids the two frequencies in question, and that may be all that is required of Sirius.

4. The Resignation Of An XM Board Member - The resignation in and of itself was not really the issue here. The issue centered around the comments that Roberts made. He hinted at a financial crisis on the horizon for XM. The street did not take the news lightly. Since that time, XM has refinanced their debt load to allow much more favorable cash flow going forward. There will be some impact in Q2, but the outlook after Q2 will be much better.

5. Class action Suits - This issue is ongoing, and is not likely to simply vanish. There are now nine law firms in on the action, and this issue could continue to be a small cloud for a while. Some feel that the case has no merit, but others argue that there are a couple of events that simply can not be denied. First, the resignation of Roberts from the board. You can be sure that the attorneys will harp on this point, and why Roberts resigned. Second, the appearance of XM's Gary Parsons on Jim Cramers CNBC show on the day other XM executives were selling shares. Parson's indicated on the show that subscriber targets would be hit, and gave a positive picture for XM. Subsequently, XM missed subscriber targets, and announced major losses.

6. General Motors Woes and Delphi - general Motors is in some trouble, but that in and of itself should not really impact XM. The perception however is that if GM is in trouble, XM will be in trouble. That perception may be misguided. GM has committed to about 1,550,000 installs in 2006. Even lower production of GM vehicles would likely not impact XM. It would simply mean that the 1,550,000 installs would represent a bigger piece of the GM production pie. The cloud here is with Delphi, and the potential of a strike. Should Delphi's workers go on strike, it could potentially DRASTICALLY impact GM production. This, depending on the length of stoppage in production could have a direct impact on XM. In reality, it is more likely than not that the judge in the Delphi case will tear up the current UAW contracts (SSG Opinion based on other happenings in the industry). The UAW will more likely than not make concessions before such an event took place. In the opinion of SSG, the chances of a strike are slim, and the chances of a prolonged strike are even slimmer. This cloud has potential to evaporate quickly.

7. FCC Investigation Into The SKYFI2 - This, in the opinion of SSG is simply a non-event. The SKYFI2 had some emissions that the FCC states are against regulations. This particular unit is likely not even in production any more, and in the opinion of SSG, the likelihood of a recall is very minimal. It is possible that the FCC could issue a small fine for the problem, but the amount of the fine is not something that would have a deep material impact on XM. If this is a cloud at all, it should not be in our opinion.

8. FTC Investigation Into XM Marketing Practices - Some speculate that this is tied mostly to marketing the XM service to subscribers in OEM promotional periods. XM however is a big company, and is likely familiar with the regulations. There may be some repercussions to this issue, but similar to the FCC issue, they should not be material in nature on an overall basis.

9. WCS Spectrum - For many investors this is a legitimate concern. XM is paying 5,500,000 shares for the spectrum if the deal is approved. Additional band-width is great, but what investors want to know is what is planned for it. XM has not been very forthcoming on the issue as yet, but has stated that they may be seeking financial partners for it. The spectrum does not cover the whole country, but does cover 15 markets. Investors are wondering about buildout costs, as well as whether or not this business plan will be a drain on the company, or push back positive operational cash flow. If an investor had a question mark about XM because of this issue, I could not take exception to their position. There simply are to many unknowns with this aspect of XMSR.


It seems that the clouds could be clearing, and that this sector now sits in a "partly cloudy" area. Hopefully with annual meetings and the Q2 reports, some clarity to these issues will be given. At this point, one could argue that both equities are oversold, and that perhaps XM is more oversold than Sirius. If as an investor you believe in the satellite radio concept, and you believe that these companies will continue to grow while at the same time improving the bottom line, then you may well see this area as an entry point. Many analysts currently feel that both Sirius and XM are currently trading well below where they should be, and they seem to have a consensus on a bullish outlook for the SDARS equities. Readers can refer to excerpts from many analysts reports here on our site.

Satellite Standard Group is not a Financial Advisor. SSG fully encourages readers to conduct their own research and seek the advice of a Certified Financial Planner prior to making any investment decisions. This write up contains opinions.

5/10/2006 08:48:00 PM

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