XM Satellite Radio (Nasdaq: XMSR ) is broadcasting a double dose of bad news today. Fourth-quarter earnings fell short of analysts' expectations. Fellow Fool Rick Munarriz is covering that announcement. More interesting to me is an SEC filing revealing that board member Pierce Roberts has resigned because he sees "a significant chance of a crisis on the horizon." Is he right?
Before answering this question, it's worth taking a quick look at the backgrounds of some other board members. You have executives with experience at DirecTV (NYSE: DTV ) , General Motors' (NYSE: GM ) OnStar division, and XO Communications. This is not a collection of former Congressional members seeking to pad their retirement income.
Let's meet Mr. Roberts
What interests me is Mr. Roberts comment -- in his email resignation -- that he has made his analysis of the company in an "increasingly vociferous manner." He concludes, "It is clear to me that I cannot be part of the solution and I will not be part of the problem." Its pretty clear that he feels ineffective.
Before writing Mr. Roberts off as just a disgruntled board member, realize that he headed Bear Stearns' (NYSE: BSC ) telecom investment banking group from 1993 to 1998. That certainly qualifies him as a number cruncher with a pedigree that would be prized by XM, a company that was destined to burn through a significant amount of cash in its initial years.
Mr. Roberts also has significant XM holdings and, to the best of my observation, no recent sales. So he's outing a company in which he has a substantial investment. Now that's worth noting.
The company's take
The company did include in its SEC filing a statement suggesting that the disagreement was over "the strategic balance of growth versus cash flow." That's fancy business speak for Mr. Roberts wanting cost controls in order to control the cash exiting the company. As an investor who has considered investing in satellite radio many times -- and always backed away even when it became a Motley Fool Rule Breakers pick -- Mr. Robert's desire for early cash generation is one I share. It's nice knowing the board had a member expressing this view, but on the other hand, it's sad to see such a voice exiting the board room.
XM and competitor Sirius (Nasdaq: SIRI ) have used the sale of shares and debt to fund the costly process of building a satellite radio company and filling its channels with programming that consumers will be willing to pay $12.95 a month to hear. For that matter, it also bears mentioning that despite torrid revenue and subscriber growth, marketing costs and COGS have grown at nearly the same rate. For what it's worth, the company alleges the increase in marketing costs was one-time.
For shareholders, another question of merit has to be, "When will the dilution stop?" In 2004, XM sold 7 million shares, which is equivalent to 4.8% share dilution. That was after a $150 million secondary offering in September 2003, and was followed by a $300 million offering last June. In January, the company converted $52 million in convertible discount notes in 17.1 million shares. The outstanding share count stands today at 222.2 million stubs.
The company says it can reach cash-flow breakeven by the end of 2006. That's great, if it happens. But the latest quarter's operating loss of $213.6 million was well above what was expected. Surprises along the way could easily keep losses flowing and the share count rising.
So should investors listen to Mr. Roberts and cover their wallets with their hands when their broker suggests an XM investment? Answer: Investors should do the math on XM first and then decide for themselves.
At the end of 2006, Hyundai plans to make XM satellite radios standard equipment on its cars. Toyota (NYSE: TM ) will start factory installation of XM radios later in 2006, while GM and Honda (NYSE: HMC ) continue to ramp up their factory installation programs. XM plans to grow from its 6 million member base in January to over 20 million in 2010, and the building blocks look to be in place for that growth.
So investors need to decide whether $3 billion in revenue in 2010 is the elixir that will hold the stock's price up until then. It may very well be, but there are three unknowns:
- What will margins be?
- Will monthly pricing be cut to compete (delaying reaching that sales level)?
- How many shares will be outstanding?
Because of these unknowns, I think Mr. Roberts is right to be worried by the free-spending ways at XM.
Satellite radio is a fantastic technology that is undeniably rapidly growing. That said, I think there are many opportunities in the Rule Breakers portfolio that don't come with as many risks and unknowns.