XM Radio's Ups and Downs

Irony reigns supreme on this week's installment of XM Daze.

Just seven days after XM Satellite Radio, the larger of the United States' two satellite radio operators, triumphantly announced an expansive, three-year, $55 million deal with the Empress of Talk Shows, Oprah Winfrey, to launch a new "Oprah & Friends" radio channel in September, XM Satellite Radio Holdings, Inc.'s fourth quarter losses soared alarmingly to $270.4 million, or $1.22 per share, after dividends for preferred stockholders. In the same period a year earlier, losses amounted to $190.4 million, or 93¢ per share.

While revenue more than doubled, from $83.1 million in the fourth quarter of 2004 to $177.1 million in the fourth quarter of 2005, the gains were partially offset by a big jump in the net average cost that the company incurs for adding subscribers. Solicitation costs rose to $141 per subscriber in the last quarter of 2005, up from $104 in the same period in 2004.

XM also continued to heavily fund expansion, almost doubling marketing costs in the last quarter to $196.5 million, and tripling programming costs to $30.6 million.

For the full year, XM posted a loss, after preferred dividends, of $675.3 million, or $3.07 per share. This compares with $651.2 million, or $3.30 per share, last year. Revenue rose to $558.3 million from $244.4 million.

The response: Company officials downplayed the losses. Explaining that the jump in subscriber and marketing costs was unusual, they said they expected the figures to drop significantly as advertising spending declines in the coming year.

One reason for XM's increased expenses was the need to one-up its competitor, Sirius Satellite Radio, Inc. (Sirius boasts more than three million subscribers compared to XM's more than six million). XM's deal with Oprah Winfrey can be seen as a response to Sirius' signing of attention-getting shock jock Howard Stern last fall.

Another factor was General Motors Corp.'s continuing woes, capped by a sluggish fourth quarter. GM is XM's largest automotive partner.

XM's president and CEO, Hugh Panero, framed the losses with optimistic projections for the future.

"2005 was a significant growth year for XM, in which we added more than 2.7 million net subscribers," he stated in an official company press release. "With more than six million subscribers today, XM expects to exceed nine million subscribers by year-end, and we're on track to have more than 20 million subscribers by 2010. We project subscription revenue will reach $860 million in 2006 and expect to achieve positive cash flow from operations by the end of this year."

Bye-bye: Nonetheless, the company was rocked by the unexpected departure of Pierce J. Roberts Jr. from its Board of Directors. Roberts, the former chief telecom banker at Bear Stearns, had served on the board for five years.

Roberts' resignation letter, received by XM board chairman Gary Parsons and fellow board members on February 13, expressed his disagreements with Board members regarding certain aspects of the company's operational direction and priorities. Although the letter did not explicitly state the nature of the disagreements, Associated Press business writer Seth Sutel reports that Roberts was "troubled" by the company's current path.

"Given current course and speed there is, in my view, a significant chance of a crisis on the horizon," Roberts reportedly wrote. "Even absent a crisis, I believe that XM will inevitably serve its shareholders poorly without major changes now."

XM's share price dropped 5% to $23.98 in response to the news of its fourth quarter performance and Roberts' resignation.

XM Satellite Radio issued the following response:

"... the Company believes the disagreement with Director Roberts primarily involves the strategic balance of growth versus cash flow. Director Roberts has historically favored more stringent cost control in the Company, specifically involving lower marketing, programming and promotional expenditures. While Director Roberts believed that expenses could be lowered without jeopardizing subscriber and revenue growth and/or market share, he was prepared to risk growth or market share impacts if they resulted, with the belief that positive cash generation would occur sooner, and the Company's stock would be valued more highly as a smaller, but more profitable enterprise.

"The Company and other Directors concur in Mr. Roberts' assessment that lower programming and marketing expenditures, and a potentially lower growth rate, would likely result in earlier positive cash generation. The other Directors, however, believe that the Company's high growth rate, market leadership and large base of subscribers are strategically important assets to ensure the Company's long term value and can be sustained while also reaching positive operating cash flow later this year. These differing views of strategic direction and balance between growth and profitability have been voiced openly for a number of years, but Director Roberts states that he can no longer be effective given the ongoing disagreement with management and the other Board members regarding the relative importance, risks and priorities of these two common goals."

Some market analysts echoed Roberts' concerns. Standard & Poor ranks XM's debt CCC+, seven levels below investment grade. It rates that of Sirius CCC, eight levels below. Merrill Lynch's Laraine Mancini noted to her investors that she was disturbed by XM's cost management practices. "We hope that an insider disagreement could force a shift in strategy," she wrote.

"They have been in a startup mode for a very long time, and have been in a negative cash flow mode for a very long time," Heather Goodchild, chief media analyst at the Standard & Poor's debt rating agency, told the Associated Press. "If the capital markets became less receptive, you could envision the music stopping and not enough chairs being there."

Is the glass is half full or half empty? It depends upon your perspective. Of primary concern to music lovers, XM and its rival Sirius offer a vital alternative to "terrestrial" radio's increasing capitulation to monopolies that care more about lowest common denominator ratings and advertising sales than quality programming. To the extent that extraterrestrial radio may be orbiting without a net, it is the joy of music lovers on not so terra firma that would be diminished were it to crash and burn.