Issuing debt doesn't always have to be a bad thing. That was the case on Monday, when XM Satellite Radio (Nasdaq: XMSR) announced a proposed offering for $600 million in new debt. The primary use of the new senior notes will be to pay down -- or pay off -- some of the company's older debt tied to interest rates that go as high as 14%.
It's not as if the company is smarting for liquidity -- its balance sheet is brimming with $711 million in cash. True, that's more than offset by the company's long-term debt balance of $1.036 billion, but it will be years before those notes come due.
Maybe there was a time when a company like XM was risky enough to warrant a junk bond's ransom, but the company has established itself as a survivor. The company topped the 6.5 million subscriber mark last month. It's aiming to turn cash flow-positive by the end of the year. And given the company's fixed overhead, XM's financial picture will improve substantially once it grows beyond its breakeven point.
Earlier this year, J.P. Morgan analyst Barton Crockett published an XM profit model in Barron's that shows how the company will be able to make more with every incremental user. Barton projects free cash flow of $188 million next year on 12.5 million subscribers, but he sees free cash flow soaring to $1.411 billion three years later on 22.9 million subscribers. Yes, a better than sevenfold spike in free cash flow can be achieved, even if the number of subscribers doesn't quite double between 2007 and 2010.
Figures like those explain why the stories at XM and Sirius (Nasdaq: SIRI) are so compelling. Cynics will jab at the two companies and argue that they are losing a ton of money. Yet the critics ignore the clear road that each company is following toward near-term cash flow profitability. Pundits will argue that the companies are debt behemoths, but each company has a substantial cash balance.
One of XM's creditors happens to be General Motors (NYSE: GM), which is likely to be one of the first debt obligations that XM repays with its newfound greenery. A few years ago, no one would think that XM had the brighter financial prospects than the mighty GM, but now, the troubled automaker could use the infusion.
Issuing new debt as a way to buy back paper at higher rates will naturally lower XM's cost structure. A Bear Stearns analyst told Forbes that he sees the move saving the company between $10 million and $15 million annually in interest payments, as well as pushing back some of the maturities. It's a smart move for a key player in the right niche.
Whether it's XM or Sirius domestically, or a company like WorldSpace (Nasdaq: WRSP) overseas, satellite radio is winning over terrestrial-radio fans by the digitally beamed boatload. That's why XM was recommended to Rule Breakers newsletter service subscribers last year.
This doesn't mean that credit rating agencies will be embracing XM with open arms and great debt-grading scores. Even so, if the proposed offering is completed according to plan, XM will have more breathing room. And with such wide-open spaces available for this booming industry, breathing room can be a great thing.
XM is an active recommendation in the
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Longtime Fool contributor Rick Munarriz has been a Sirius satellite radio subscriber since 2004, but he does not own shares in any of the companies mentioned in this story.
The Fool has a disclosure policy. He is also part of the
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