If I told you that a certain company has diluted its shares at an alarming rate over the past three years, what would you say about it?
How about if I told you that this same company has burned through hundreds of millions of dollars in cash over the same time span and now has long-term debt of more than $1 billion? With the result that its book value has plunged from $1.16 per share to negative $0.14 per share?
Might you then agree with me that this stock is likely to be the worst-performing stock of 2007?
Meet the yo-yo
If so, then it may surprise you to learn that you are -- and I am -- in the minority. Because just 20 months ago, the stock that fits the description I've laid out above, Sirius Satellite Radio (Nasdaq: SIRI ) , was voted the best stock on the planet in the Fool's inaugural Stock Madness tournament. If you're not familiar with the company, Sirius, along with arch-nemesis XM Satellite Radio (Nasdaq: XMSR ) , is one half of what I've on occasion described as the " twin yo-yos of satellite radio." Like XM, the company aims to duplicate in radio the revolution that took place with cable television some 30 years ago -- charging a fee to provide higher-quality service on a formerly free product.
Of course, as you might guess by this contest's name, logic and cold, hard discounted cash flow analysis played only a small part in Sirius' winning the Stock Madness tournament. Rather, Sirius emerged victorious in large part because of the support of some less-than-Foolish boosters (like these), who voted their dreams rather than their wallets. After weeks of play gave way to our post-game autopsy, we found that many of the investors who voted for Sirius, along with two of the other three semifinalists, Apple (Nasdaq: AAPL ) and Netflix (Nasdaq: NFLX ) , took the athletic theme of the tournament a bit too much to heart, acting the part of "ardent sports fans." As Stephen Simpson opined at the time, "people really seemed to invest a great deal of ego in the success of 'their company'". Which is fine in the context of a game, but as Stephen further pointed out: "With stocks, though, unwarranted enthusiasm can strike you quickly in the pocketbook."
"Winning" the Stock Madness tournament turned out to be a Pyrrhic victory for the traders who carried Sirius on their shoulders to victory. Since then, the stock has shed more than 30% of its value.
Everything is relative
Yet Sirius is arguably a better investment today than it was back in April 2005. On the revenue front, the company boasts four times as many paying customers as it had back then. And examining profitability trends, we see that gross margins have nearly tripled over the past year, while operating margins are about half as negative as they were one year ago.
But better" isn't yet "good." Although Sirius is moving toward GAAP profitability, and although management wistfully suggested that its "first quarter of positive free cash flow, after capital expenditures, could be reached as early as the fourth quarter of 2006," that would still leave Sirius far short of being a profitable operation. Historically, the fourth fiscal quarter often brings Sirius closest to cash profitability. Of the three times when Sirius has booked positive cash from operations in the past, two occurred in the last quarter of the fiscal year. Last year, Sirius came within striking distance of its goal, with cash flow from operations of just negative $15.6 million in Q4, while it spent $31.9 million on capital expenditures.
But here's the thing: There's more than one quarter in a year. Even if Sirius does generate a cash profit this Q4, it's still burning through cash at the rate of $550 million over the course of the other three quarters. That means the company will need to continue piling on the debt, or diluting its shareholders with stock issuances -- or both -- to keep its operations running.
While this is certainly "better" than the alternative -- throwing in the towel and declaring bankruptcy -- it's a far cry from "good."
Agree with me? Great. Disagree? Even better. Come on over to Motley Fool CAPS, and tell the 400-plus Fools who have rated Sirius an underperformer why we're wrong. If you've got a proven record of being right yourself, and can make a compelling case for why Sirius is a "buy," you might just persuade us to give this stock a second star.
Want to go back to the beginning of our Worst Stock for 2007 tournament? Right this way.
Netflix is a Motley Fool Stock Advisor recommendation. XM is a former Rule Breakers pick.