Thursday, May 11, 2006

The Wall Street Journal Takes an interest in Satellite Radio

May 11, 2006


Tuning In Institutional Holders

XM Is Outrunning Sirius in RaceTo Replace Individual Investors With Steady-Eddie Mutual Funds


May 11, 2006; Page C1

Gary Parsons, chairman of XM Satellite Radio Holdings Inc., was gratified in 2004 when blue-chip mutual funds began taking or increasing their stakes in his company. The bets made by investors like TCW Asset Management, Fidelity Investments and Wellington Management were a sign that long-term investors were taking XM seriously.

XM's smaller rival, Sirius Satellite Radio Inc., is still in the takeoff position with institutional holders. Although it has attracted some white-shoe investors like Fidelity, the bulk of its holders -- around 72% -- are individual investors.

For many start-ups, moving into a base of institutional shareholders, from the hedge funds and individual investors who typically hold the stock in the early stages, is an important goal. Institutions tend to be long-term investors with patience to ride out negative news, as has been the case particularly at XM recently. Individuals and many hedge funds, however, can be more idiosyncratic, trading on short-term news or because they need to dump stock to pay for something else, like a home or college.

In the case of satellite radio, which started airing in late 2001, XM has made the transition, with 95% of its stock now held by institutions. While the term institutions includes hedge funds as well as mutual funds, analysts believe it represents a heavy mutual-fund orientation in XM's case. "It's smart money versus fast money," Mr. Parsons says.

Why are XM and Sirius, which have been on the air for about the same length of time, viewed so differently by investors? The answer lies partly in the slight head start XM got on Sirius when both companies were start-ups, and partly in XM's ability, so far, to better rein in costs for technology, marketing, programming and customer acquisition.

"They were further along in their business plan," says Anthony Valencia, a media analyst at TCW, one of XM's largest shareholders. "The XM management team had more of a following, more of a profile with Wall Street."

In some ways, Sirius looks more attractive. It has brand recognition, in large part thanks to hiring Howard Stern away from his gig with CBS Corp.'s CBS Radio. It is expanding faster, tripling its subscriber base to 3.3 million at the end of last year. It is lowering costs, and it had $715 million in cash on hand at the end of the first quarter, compared with about $521 million for XM. And unlike XM, Sirius isn't relying heavily on a struggling General Motors Corp. to get its radios into car dashboards.

But XM looked like a better value to institutional investors -- and to many it still does. XM trades at about five times 2006 sales, compared with 10 times sales at Sirius. XM's enterprise value, which includes debt as well as equity capitalization, implies a value of $761 for each projected subscriber this year. Sirius's enterprise value implies a value of $1,309 per projected subscriber, according to Jonathan Jacoby, an analyst at Banc of America Securities.
This year XM will pay about $98 in costs like incentive payments for adding each new subscriber, estimates Mr. Jacoby. By contrast, he believes Sirius will pay about $157, although that would be down significantly from $199 last year.

In 4 p.m. composite trading yesterday on the Nasdaq Stock Market, XM's shares were down 73 cents to $17.47, giving the company a market capitalization of $4.5 billion. Sirius stood at $4.54, down nine cents. It has a market cap of $6.3 billion.

Unfortunately for XM, its bigger institutional base hasn't done much to halt its recent stock slide, though analysts say it would have been worse without the long-term mutual funds that hold the company. Since the end of March, its shares have dropped 18%, while Sirius's are off 7%.

For XM, the slide stems from a flurry of negative news. In February a director resigned, citing cost controls and "a significant chance of crisis." Last month it reported a widening loss in its first-quarter results, an investigation by the Federal Trade Commission over its marketing practices, and another investigation by the Federal Communications Commission over interference caused by one of its car-radio models. Then on May 3 shareholders hit the company with a class-action lawsuit, alleging that XM misled investors over its subscriber-acquisition costs and its subscriber goals. They also alleged that executives, including Chief Executive Officer Hugh Panero, sold off huge chunks of stock ahead of the news.

Sirius, too, has had its own static to deal with. In 2002, it underwent a major restructuring, issuing new stock and diluting the stake of existing shareholders to 8%. Its CEO, Mel Karmazin, at the helm now for 18 months, has cut some expenses and stepped up subscriber growth. Sirius posted a first-quarter loss of $458.5 million.

David Williams, who runs the $7.1 billion Excelsior Value & Restructuring Fund for U.S. Trust, says "it would take an awful lot" to interest him in Sirius. "It would take a really positive financial surprise," he says. Yet Mr. Williams just bought an additional 100,000 shares in XM, adding to the 5.6 million shares he bought in 2003. "Less risk, bigger, much cheaper than Sirius," he explains.

By getting into XM early, when its stock was well under $5, Mr. Williams got a better deal than the fund managers who piled in during 2004 and 2005. Those investors are mostly underwater, especially if they bought at the end of 2004, when the stock traded above $40 a share. But so are Sirius investors who got in at that time, when the stock traded as high as $9.01.

One reason mom-and-pop investors may like Sirius better: It has 1.4 billion shares outstanding, compared with XM's 258 million. For many investors, that makes it an easier buy psychologically, because each share appears cheaper on an absolute basis, even if it represents a smaller piece of the pie.

5/11/2006 06:39:00 AM

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