Keeping Score on Satellite Radio
The Dog Star suddenly looks like a balloon in search of a pin.
 Two
years ago I predicted XM and Sirius would have a tough time surviving
in the midst of a hard recession while using business models based
on tons of red ink far into the future. Surely shareholders would
run out of patience and hold them accountable for more rational
balance sheets and business practices before rewarding them with
higher stock prices.
I think I ignored the lessons of the dot-com bubble and investors'
willingness to ride a hot pony with irrational exuberance. Or perhaps
I just didn't give them enough time before reality would set in.
The market has leveled off and pulled back into a choppy trading
range and appears to be taking a more sober look at what the prospects
for these companies really are. Numerous investment advisors are
dropping their calls to neutral or outright sell. Of course, satellite
stock prices have jumped around a lot, and probably will continue
to be volatile in the near future.
Back in 2002 it seemed likely the much smaller Sirius would falter
and merge or morph into something else. That hasn't happened. Yet.
After leaving Viacom and losing interest in traditional media, Mel
Karmazin has ridden in on a white horse with sidekick Howard Stern
to keep the Dog Star burning for now. But even Mel may have lost
his magic touch with Wall Street. After his recent press conference
touting the latest Sirius video add-on feature, for example, the
stock immediately sold off 5 percent.
HEARING FOOTSTEPS
The dot-com boom and bust cycle lasted about eight years. Could
satellite radio be following in the same footsteps? There are many
parallels and similarities. I only regret that I didn't buy them
two years ago and then sell a few months ago to reap profits approaching
1,000 percent.
Instead of shoring up their business plans by restructuring and
scaling back risk like any typical young company struggling to become
profitable, they're going in the opposite direction. Both have tried
to enhance their content offerings and appeal by increasing programming
commitments and debt while diluting their share values by issuing
more stock. The only thing saving them for now is a steadily growing
subscription base. That's the key difference between these companies
and many dot-coms that had nifty ideas and a few products but not
enough buyers. Wall Street eventually lost its patience with the
dot-com bubble businesses and many bit the dust.
The obvious challenge for satellite radio is to keep growing fast
enough to convince investors they will turn the corner and become
profitable over the long haul. As happened after cable and satellite
TV were launched and grew rapidly, subscription growth eventually
leveled off and churn rates increased. XM and Sirius hope to cross
the threshold of profitability before that happens. As of January,
XM counted more than 3 million and Sirius had 1 million subscribers.
Both have a very long way to go.
MAKING THE CASE
Radio isn't television. Even in large markets, the selection of
over-the-air TV programming was very limited compared to what could
be delivered over cable and satellite. Those services have succeeded
because most American households have been willing to pay to get
a dramatic increase in viewing choices, all with near-perfect pictures
and reception.
According to Leichtman Research, the total number of cable and
satellite TV subscribers is about 90 million in the United States.
First we heard the sat radio boys thought they could eventually
count half that many who will buy their service. Now, Karmazin is
saying they might even equal that many. Nobody ever accused these
guys of not being supremely optimistic.
The case for pay radio is nowhere near as compelling as pay TV's.
The most important and valuable radio listening is mobile during
drive times. Coverage of local news, weather, traffic, sports and
civic events is still the most powerful reason folks turn on the
radio. Even in average-sized cities, the number of viable radio-station
choices is 20 or more, with many major formats available. CD players,
Walkmans, i-PODS and portable MP3 players augment the majority of
listening needs and choices for music aficionados. The universe
of those who are willing to pay for more radio programming and music
choices beyond these traditional methods will most certainly prove
to be a small fraction of that enjoyed by pay TV and video.
Sirius is basing much of its future growth on Howard Stern and
NFL football, while XM has high hopes for its Major League Baseball
deal. Practically all industry observers have noted the prices paid
for such marquee content were ridiculously high. The Wall Street
Journal has said Sirius is "crushing its own windpipe"
with such deals. XM has also added the infamous Opie and Anthony
(O&A), plus popular talkers Dr. Laura and Gordon Liddy. The
price of good talent honed in traditional radio is being bid way
up and a few are crossing over.
Both companies, but especially Sirius, are betting that new subscribers
will pay the extra freight and sometime in the future a profit will
be made. They keep upping the ante in spite of the odds their bet
may not pay off. They're also hoping subscription sales will just
keep on rolling after consumers who really want the service buy
it separately by including the cost of new subscriptions in the
purchase of new cars. Dealers can easily bury the sat radio charges
in the monthly car payments in hopes buyers won't really notice
or remember they agreed to pay for the service.
GOING OVER THE LINE
In its zeal to enforce indecency standards, the FCC effectively
has forced several bad-boy jocks off regulated free radio onto satellite.
Opie and Anthony are on XM doing their shtick in unexpurgated fashion.
Citadel has chosen to replace Stern in some of their markets with
O&A as fill-ins. The dump buttons and post editors must be getting
a real workout. Presumably, they're doing this as punishment for
Howard spending too much time promoting Sirius and his new show
that starts there unfettered by FCC regulations next year.
I'm surprised neither Mel nor Howard have thought about why his
show was so popular with indecency restrictions, but why it might
not be so attractive without them. Those very limits force such
talent to create suggestive and titillating radio bits that "come
very close to the line" without going over it.
Both Howard's and O&A's fans are largely folks who enjoy hearing
how far the creative genius will go and what they will say next
without dropping over the edge. Without limits, this "art form"
quickly degenerates. Most everyone values some level of decency
and the power of imagination. That's why well-produced soft porn
attracts much larger audiences than no-holes-barred XXX. It won't
take too long to find out if these guys justify their huge salaries
as bona-fide stars or just morph into dirty old men being disgusting
all too often.
When XM and Sirius first launched, both CEOs said they could compete
and coexist like Coke and Pepsi. If that's the case, traditional
radio must be water. XM maintained if they could only attract 10
percent of traditional radio's daily audience of 225 million, they
would be successful. But their thresholds of profitability have
steadily increased along with the mountains of debt. And now they
truly believe they can stretch that number to 45 or even 90 million?
Such extravagant projections are going to be reined in by the counter-competitive
impact of traditional free radio's fledgling transition to digital
with multiple channels and many of the same add-on features like
text data and 5.1 surround sound.
DOING THE MATH
Jesse Eisinger broke down the market valuation numbers for Sirius
in his Wall Street Journal article in December.
At $9.02 a share (the stock price at that time), its market value
based on 1.74 billion owned shares was $15.7 billion. If each subscriber
generates about $12 a month in revenue, that totals $144 per year.
But investors look at "contribution margin," which measures
cash flow after most variable costs except marketing and SAC or
subscriber acquisition costs. Sirius expects a 70 percent contribution
margin so the $144 "net" value of each subscriber is reduced
to $100 per year.
The Sirius "churn rate" is always being debated, but
a reasonable estimate is 2 percent per month or 24 percent a year
for this exercise, he noted. That means after four years, the equivalent
of all subscribers roll over or churn off. Consequently the contribution
margin becomes $100 times four years or $400. But we also have to
subtract the SAC. That number was $200 for 2004, but Sirius is hoping
and analysts are projecting that this number could be reduced to
$50 in the future. Allowing for a very generous $50 SAC, we now
have a value of $350 for each Sirius subscriber. Divide the market
cap of $15.7 billion by 350 and you can then project that the market
is valuing Sirius as if it has 45 million subscribers, instead of
the real-world 1 million.
The Dog Star suddenly looks like a balloon in search of a pin.
BALANCING THE BALANCE SHEET
Despite highly inflated expectations and stock prices, satellite
radio does bring a valuable alternate service to the marketplace
that extends and augments what traditional radio has done for 85
years. But at what price to consumers that will sustain the providers
as viable businesses?
The economics of both Sirius and XM still seem way out of balance
at present subscription rates and income levels. Something will
have to change. Higher monthly fees, along with tiered surcharges
for "premium" features like Stern and NFL games, are only
months away.
When both services first launched, much of the hype and attraction
was over their "commercial-free" programming. Few clear-thinking
observers thought that would last very long. Over the past year,
commercials have started to appear. Most of the Sirius talk channels
now include commercials. Karmazin, who started his career as a CBS
radio spot salesman, never lost his lust for ad dollars. He recently
divulged his fervent desire that 5 percent of all radio ad revenue,
about $1 billion, would flow into Sirius. Stop sets of multiple
commercials on the music channels could be just around the corner
Nobody ever mentions the issue of satellite vulnerability involving
these services. "Rock" and "Roll" and the Sirius
birds are insured, but a technical flaw with Rock and Roll projects
their life span to only seven or eight years instead of the planned
15-year target. XM now will have to launch two more replacement
satellites over the next two years to cover the shortfall.
With all the things that can go wrong, having multi-million dollar
standbys ready to blast into orbit on short notice seems mandatory.
All it takes is for one lucky asteroid or some errant piece of space
junk to crash into any of these and instant catastrophic damage
could result. This technology has proven to be reliable and durable
so far, but loss of service for any extended period of time could
wreak havoc and huge financial losses for either.
LOOKING AHEAD
In spite of an insatiable appetite for spending and debt, almost
everyone seems to agree that satellite radio is here to stay. But
very soon, real and significant cost-cutting measures are going
to have to be a part of their operations. This may already be happening
at Sirius under the frugal hand of Mr. Karmazin. While an XM/Sirius
merger is a future possibility, the most likely scenario that will
ensure the survival of these services will be increased ownership
and control by major investors like the automobile companies and
large group traditional broadcasters.
When subscriber growth flattens out and these companies still find
themselves bathed in red ink, Wall Street undoubtedly will exact
its punishment. At that point, the underlying owners will become
more actively involved in restructuring the business models that
could then subdivide and transition either XM or Sirius into consolidated
sub-units of traditional radio. Failing AMs were bought up by profitable
groups and FMs over the past 20 years. The new owners had to subsidize
the AM operations until they could be transformed into profitability.
As unthinkable as it may sound, Mel could be the tip of that iceberg
in reverse, as many of the present employees of XM and Sirius could
once again be working for their old bosses in radio companies they
left behind.
RW welcomes other points of view. Write to radioworld@imaspub.com.
Guy Wire is the pseudonym of a well-known veteran radio engineer
who prefers to remain anonymous. His opinions are his own and do
not necessarily reflect those of Radio World.
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