The Worst Stock for 2007: XM Satellite Radio

When I look at companies like XM Satellite Radio (Nasdaq: XMSR  ) , I can't help remembering a frequent maxim from my old boss and mentor in the seaports industry -- "Remember, Philip, we have to avoid profitless prosperity." He was referring to the practice of having a winning business without regard to how much it would cost us to provide the service. I never forgot that maxim in business or in my investment research.

Profitless prosperity
My old boss' definition of profitless prosperity fits XM Satellite Radio to a T -- rapidly increasing numbers of customers and revenue, but an even greater increase in operating costs. Sure, the investment thesis is that grabbing customers hand over fist is the right strategy to set up the company for big profits in the future, but just when will that future arrive? In the meantime, the company is funding its cash deficit with equity offerings and increased debt.

(Numbers in Millions)

2001

2002

2003

2004

2005

TTM

Revenues

$0.5

$20.2

$91.8

$244.4

$558.3

$835.3

Net Income

($284.4)

($495.0)

($584.5)

($642.4)

($666.7)

($730.5)

Shares

75.3

101.3

185.0

210.9

257.9

268.5

Long-Term Debt

$411.5

$412.5

$743.3

$948.7

$1,035.6

$1,342.6

Equity Value

$926.7

$592.3

$532.9

$336.2

$80.9

($253.2)

The equity value row is particularly telling -- even as the company bolsters its equity through frequent share issues, it still manages to destroy shareholder value. The only way this could possibly make sense is if the company could eventually dominate its industry and become the eBay (Nasdaq: EBAY  ) or Amazon (Nasdaq: AMZN  ) of the airwaves, but I just don't see that happening. Not now, not ever. For starters, the company has direct competition from Sirius (Nasdaq: SIRI  ) for the very same customers. It's also up against free terrestrial radio as well as Apple's (Nasdaq: APPL  ) iPod and other MP3 players.

Chasing cars
XM's best hope appears to be with original installation in new cars. I can certainly see the company continuing to increase its subscriber numbers through this channel. However, not all drivers will pay a monthly subscription, even if the equipment comes installed. Many, like me, are content with free terrestrial radio for local news, traffic updates, and sports, and many prefer to choose their own music via an MP3 device. Car manufacturers know that, too -- most new cars now accept inputs from such equipment. Another problem for XM is that auto manufacturers such as GM (NYSE: GM  ) and Honda (NYSE: HMC  ) charge XM for the privilege of installing their equipment and take a cut of the monthly fee.

Foolish final word
All pre-profit companies predict that they will grow their way to profitability and consequently emphasize sales and, in XM's case, subscriber growth.

If you're hanging on to this stock, I suggest you think again. At the end of 2005, the company had 5.9 million subscribers and was predicting 9 million by the end of 2006. However, growth has slowed dramatically, and at the end of the third quarter, the year-end estimate figure had slumped to between 7.7 million and 7.9 million. If you add on increasing customer acquisition costs, plus increasing churn (customers that don't renew), then I think you'll get the picture -- ultimately, satellite radio will never appeal to a big enough market to make XM's predictions of 20 million subscribers by 2010 a reality. There are too many other cheaper and more convenient alternatives, and I'm confident that you can get far better value for your investment dollar elsewhere.

What do you think about XM in 2007? Make your voice heard on Motley Fool CAPS, our free community-investing database. Simply vote XM "outperform" or "underperform" relative to the S&P 500. The stock gaining the most "underperform" votes will get the award for being The Worst Stock for 2007. Follow this link to get in the game.

Want to go back to the beginning of our Worst Stock for 2007 tournament? Right this way.

Inside Valuechief Philip Durell owns none of the companies mentioned. eBay and Amazon areMotley Fool Stock Advisorpicks. XM is a former Rule Breakers pick. The Fool has a disclosure policy.


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