September 17, 2008

Sirius XM Is in a Serious Bind

Sirius XM (SIRI) Chief Executive Mel Karmazin had choice words for competing radio companies during a recent conference for investors. "The reason why radio sucks, and the reason that most of you don't want to invest in it, is principally because the growth stopped," Karmazin said during the Sept. 9 event sponsored by Merrill Lynch (MER).

Tough talk from an executive who on the same day trimmed his own company's subscriber growth forecast and issued disappointing profit projections. It's true that satellite radio is outgrowing traditional forms of radio, delivered through the airwaves to AM and FM receivers. But when it comes to the bottom line, satellite radio isn't faring much better. "Terrestrial radio is going through its challenges, but I'd be hard-pressed to say the future of satellite radio is much brighter," says Tuna Amobi, an analyst at Standard & Poor's, which, like, is owned by The McGraw-Hill Cos. (MHP). Amobi has a "buy" rating on Sirius XM, reflecting the stock's recent rout.

Shares of Sirius XM, the product of the July merger of the top two satellite radio providers, have plummeted 30% since Karmazin's remarks, closing at 88% on Sept. 16, a Sirius five-year low. Investors were dismayed that Karmazin didn't boost Sirius' forecast for operating income, even though the company expects greater cost reductions from the merger. Sirius expects to add 2 million subscribers next year, 10% fewer than analysts were expecting, and a decline from the projected 2.1 million new users this year. One cause is slower sales of autos, a big generator of new satellite-radio subscriptions.

Cheaper Subscriptions Some analysts say subscriber growth prospects aren't likely to get much brighter. "The problem with satellite radio is it appeals very much to a very small group of people," says Forrester Research (FORR) analyst James McQuivey. "Once you've exhausted those people, you don't have 10 million more."

Even diehard Sirius fans may opt to downsize subscription packages once the company begins to implement measures imposed by regulators. In an effort to ensure competition, regulators demanded [, 7/25/08] that the company offer smaller, less expensive a la carte packages of channels.

Sirius faces immediate financial challenges, too. If the stock stays below $1 a share for a few more weeks, Sirius risks being delisted from the Nasdaq. Delisting would make it harder for Sirius XM to refinance more than $1 billion in debt coming due next year -- already a struggle for a loss-making company that's bleeding cash and plans to spend more than $100 million on a new satellite in 2009.

Questions of Survival Janco Partners analyst April Horace estimates that Sirius' cash balance could dip to $90 million next year, from $220 million currently. That "seems awfully low," Horace wrote in a Sept. 11 research note. Says Amobi: "The survival of this company has come back into question." During the conference, Karmazin said he is in talks with bondholders and banks to refinance. "I've been around when things were a lot worse," he said at the New York event, referring to his earlier radio career. Sirius did not return requests for comment for this story.

Karmazin's tough talk was spot-on insofar as other radio companies face big hurdles. There's not a lot of room for growth in an industry that's already reaching 235 million weekly listeners, or almost 80% of the U.S. population, according to the Radio Advertising Bureau [RAB]. Key advertisers, such as automakers and banks, are pulling back, cutting the radio industry's ad sales by 7% in the first half, according to RAB. Some radio companies' sales plunged by double-digit percentages. And one of the biggest owners of radio stations is awash in debt. CC Media, parent of the newly privatized Clear Channel, has $20.7 billion in debt, compared with $3.6 billion for Sirius.

Yet unlike Sirius, many terrestrial radio companies generate profit and cash. CC Media's net income increased in its most recent quarter, though the figure was boosted by gains from sales of radio stations. Beasley Broadcast Group, which operates 44 radio stations, reported a 12% increase in second-quarter net income. Cox Radio (CXR), which reported a loss in the second quarter, still generated cash. "We are really focusing on local [advertisers, who haven't pulled back as much as national companies]," says Cox CEO Bob Neil.

Growing Web Radio Radio stations' prospects will brighten more when the economic slowdown ends. "There's no reason why they can't increase their margins" from the current 39.4% to 45%, says Erik Kolb, an S&P analyst who rates Cox Radio a hold. These margins could widen further as radio stations expand cheaper Web operations, he says. Traditional radio off-air revenue, a category that includes Internet radio, rose 12%, to $889 million, in the first half, according to RAB. That's roughly half the amount the industry receives from national advertisers.

Online radio is likely to account for a growing percentage of business in the coming years, analysts say. CBS Radio, the second-largest provider of radio service, recently began managing all of AOL's radio channels, becoming the largest Web radio provider in the world. "We have a lot of confidence that we can be profitable in this space," says Dan Mason, CEO of CBS Radio, which is owned by CBS Corp. (CBS).

Sirius XM doesn't intend to be left behind on the Web, either. The satellite radio provider already streams 80 radio channels online and provides unique Web content for $12.95 a month. "We will be the premier company in audio entertainment in the world," Karmazin insisted at the Merrill Lynch conference.

Maybe so. But he'll need to make progress on debt, growth, and turning a profit before many investors agree.