If you missed your chance to invest in cable television in the 1980s and then missed your chance to invest in personal computers in the early 1990s and then missed your chance to invest in the Internet in the mid-1990s, then the market gods are giving you one more opportunity to get ahead of the crowd: You can invest in satellite radio right now, right here in the early ?00s.
Satellite radio is an idea that seems to have been around forever, but that?s only because hype over the technology got started long before the service actually became available. Now the situation seems to be inverted, as there might actually be less hype than the market opportunity merits, with one of the two leading companies just barely poking above penny-stock status last week after the recent announcement of surprisingly strong sales growth and a vote of confidence from a key customer.
Static at the start
Some history first: The concept of beaming commercial-free CD-quality radio down from geosynchronous orbit to cars and trucks across the country was undeniably cool when first introduced in the early 1990s. The initial player in the business -- Sirius Satellite Radio (SIRI, news, msgs) -- had no trouble raising enough money in the capital markets? bubble years to spend a billion dollars on infrastructure to make it happen. A short while later, along came a second player -- XM Satellite Radio (XMSR, news, msgs) -- with a slightly less ambitious and costly plan. And it, too, easily raised hundreds of millions of dollars in debt and equity to put the idea on an upward flight path. Compare rates.
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Predictably, however, the technology took a lot longer to get off the ground than anyone suspected, and both companies suffered long delays in putting their birds in the air. Sirius launched at around $4 in 1994 and climbed as high as $69 in 2000. But, as hope faded, debt mounted and creditors cried for blood or bankruptcy court, the shares crashed all the way to 40 cents two months ago. Meanwhile, shares of XM, which launched at around $12 in 1999 and climbed as high as $50 in 2000, sank as low as $1.66 in November.
But a single masterstroke of financial engineering combined with the desperation of automakers combined to rescue both just as investors had all but given up.
XM?s largest shareholders were also its two largest potential customers: Honda Motor (HMC, news, msgs), with a 22% stake, and General Motors (GM, news, msgs), with a 13% stake. Neither automaker had managed to excite potential car buyers with cool new vehicles in years, and both were hoping to use factory- installed satellite radio in the 2003-2004 model years as a marketing ploy to entice incremental new sales. Yet even as each company was announcing the names of up to 30 high-end models that would offer the service in 2003, XM?s financial condition was worsening. On Nov. 15, shares fell to an all-time low when XM reported a wider-than-expected third-quarter loss and it needed to restructure at least $200 million in debt owed to GM.
At that moment of critical need, XM executives pulled one of the boldest David-and-Goliath moves in recent financial history, telling General Motors to put up or shut up: Defer payments, or see their already advertised and sold service disappear down a rat hole called Chapter 11. The ultimatum worked, as the tiny company persuaded the giant automaker to give it $450 million in financing ($200 million in new funds and $250 million in payment deferrals) in exchange for notes that converted into common stock at $3.18 a share, almost double the price at the time.
Shares have since gradually advanced almost 500% from the low, as they now trade around $10. The service itself launched recently to much acclaim, and inexpensive, beautifully designed home versions of the radio system -- called SkyFi -- are one of the coolest consumer electronics items available in stores today. Virtually every week, major new vendors such as Wal-Mart Stores (WMT, news, msgs), Toyota (TM, news, msgs) Acura, Audi and Avis are announced. A few days ago, the company confirmed it was on track for sales of $85 million in 2003 -- up from $800,000 in fiscal 2001 and $20 million in fiscal 2002.
But that?s not the end of the story, as Sirius was facing its own demons up until a few days ago. After XM managed to get its creditors to trade debt for equity last year, Sirius figured it was worth a shot as well -- and in early March announced that 90% of its creditors had agreed to exchange $635.7 million in debt for 545 million shares of newly issued stock plus $200 million in new funds. In a pattern identical to the one that played out at XM, shares then declined for a few days to an ultimate low around 40 cents before weary, shell-shocked investors gradually began to lift the price toward a buck.
Burned numerous times already, investors continued to shy away from Sirius as they fretted about one last major concern overhanging the company: Why, they wondered, had Ford (F, news, msgs) and DaimlerChrysler (DCX, news, msgs) -- which had previously said they planned to install Sirius in their cars to counter GM and Honda --failed to announce any specific models due to get the service? Was it possible that Ford and DamilerChrysler would jilt Sirius and bolt over to the XM camp? If that were to happen, Sirius would be in the most serious trouble of its long and troubled life.
On April 16, however, the Mercedes-Benz division of DaimlerChrysler announced it would offer an integrated Sirius system on most of its 2004 line and BMW announced it would install the line in its hot new MINI Coopers. And last week, Ford finally announced that it would install Sirius? system in its Mustang, Thunderbird, Lincoln and Mercury lines. Car rental giant Hertz also announced it would provide Sirius in cars at 33 airports across the country. That was enough to send the shares from 69 cents in mid-April to their current perch around $1.30.
Now, the issue is service
With financing set, for now, and customers on the line, the two companies have to deliver on their promised products. And in some ways the next phase could be the most challenging of all, as they must transition from manufacturers of a technology into providers of a service. For the money in this business going forward is not in the sales of receivers, boom boxes and antennas, but in monthly subscriptions to a distinguished lineup of content.
It?s the early days of America Online (AOL, news, msgs) or Cablevision (CVC, news, msgs) all over again, as the companies will be judged each quarter not by the money they actually earn but by the number of new sign-ups -- customers whom, it will be assumed, they can rent to content providers for years to come. A monthly subscription ti Sirius runs $12.95 for 60 channels of commercial-free music and 40 streams of sports, news and talk. XM charges $9.95 per month for a service that includes about three minutes of commercials per hour.
Unlike most other technology firms that face immediate obsolescence and low barriers to entry, however, these two own exclusive rights from the federal government to broadcast radio from satellites --and the Federal Communications Commission has indicated that it intends to ensure that a duopoly (a two-company monopoly) continues in this space. In other words, the government doesn?t want either to fail, it doesn?t want either to acquire the other and it would prefer that neither is acquired by a broadcasting giant such as Clear Channel Communications (CCU, news, msgs) or a media giant like Viacom (VIA, news, msgs).
John LaForge, manager of the Phoenix-Hollister Small Cap Value Fund (PDSAX), said Sirius had been one of his rare purchases under $1 in the past six months. He said he believed the potential for a move to $3-$5 from his average purchase price of around 80 cents outweighed the risk that the creditors would fail to restructure the debt or that Ford would embrace a technology majority-owned by its top competitor. ?Sirius you buy for getting the risks out of the way and then for the cash flow from subscriptions -- not for earnings,? he said in a phone interview.
Recently, S.G. Cowen and a couple of smaller brokerages have raised their ratings on Sirius to buy or "outperform" from "sell" or "avoid," but it is far from a mainstream story yet. In a few months, the company promises to release some slick new car and home models to rival offerings from archrival XM. And you can expect the advertising machine to get fully engaged by next Christmas.
Then will come the last real moment of truth for this nascent industry, as we learn whether enough consumers find the idea of high-quality, minimal-commercial radio appealing enough to pay for. If the service passes that test -- and particularly if the two rivals decide to make radios that pick up each others? signals, obviating consumers? concerns that they might get stuck with the wrong hardware in the event that they wish to change subscriptions -- then these two once-troubled stocks should have at least one or two more doubles ahead of them in the next few years.
Xmsr looks to grow leaps and bounds. They project 1.2 million customers by the end of the year. XMSR closed at $10.25 Friday. Surely worth a look.
