Will Video Save the Radio Star?

How long have we been talking about video functionality at Sirius (Nasdaq: SIRI  ) ? Too long. I first wrote about this 23 months ago, shortly after the fast-growing satellite-radio provider announced that it was partnering with Microsoft (Nasdaq: MSFT  ) to offer up eye-candy streams.

At the time, Sirius was targeting the second half of 2006 as the time when it would launch two or three channels dedicated to broadcasting children's cartoons. It was a brilliant move. Resolution concerns would be solved by serving up animated fare that, even when grainy, holds up relatively well for an audience of "are we there yet?" bickering toddlers in the back seat who wouldn't know the difference.

Naturally, teaming up with Microsoft is often a prelude to a product delay. Vista much, anyone? However, even though the launch is now being bumped to late next year, at least the company is talking about video delivery again.

A rare step back
Sirius can use the video loving. Last night, the company spooked investors by warning that it will close out the year with just 5.9 million to 6.1 million subscribers. It had recently raised that mark to 6.3 million. This still represents spectacular year-over-year growth for the company, but it's the first time that Sirius has had to hose down its listener targets this year. Rival XM (Nasdaq: XMSR  ) has lowered its year-end subscriber count a devastating three times this year.

In other words, satellite radio as an industry isn't growing as quickly as the companies thought it would earlier this year. Even more troubling, if we combine the two companies to create a composite of the appetite for satellite radio, it's not all that tasty. XM and Sirius combined to tack on 4.9 million net new subscribers last year. Going by the mid-range estimates for 2006, XM and Sirius will snag only 4.6 million net new additions this year.

Yes, Sirius has been gaining market share at the expense of XM since late last year, but the blended snapshot has to be of concern to shareholders whether they bet on one or both horses in this race. CEO Mel Karmazin has hinted at price hikes, but now that is likely off the table in the near term. You don't follow lower guidance by upping the monthly subscriber fee from $12.95 to $14.95 or $15.95. It may not be a coincidence that XM began losing market share to Sirius two quarters after it initiated a 30% price hike in the spring of 2005.

There's another reason why both companies are likely to hold pat on fee hikes that, if well received, would prod the red-inked players closer toward profitability. Because existing subs are often grandfathered into older rates (at least initially), it would be new signups bearing the brunt of the price increases. That won't be an easy sell. By the end of this month, XM and Sirius will combine for 13.6 million to 14 million subscribers. Do you really think that the next 14 million will be willing to pay more than the early adopters? The first wave to buy in consisted of avid radio fans and folks with lengthy commutes. Logic would dictate that the service would be worth less -- not more -- to those who haven't come around to the once-promising platform.

Catalysts come in color
Thankfully, that's where video comes in. With more and more cars coming equipped with rear entertainment systems, now is the time to shine on that front. Convince drivers that satellite radio is a valuable tool in keeping unruly children from kicking the back of their seats, and you would be surprised at how quickly a casual radio buff becomes a fanatical one.

The strategy hasn't changed much in two years. At the Reuters Media Summit last week, Karmazin indicated that the plan is to launch with at least three video channels for children. The content will be ad-supported.

Will Sirius -- and eventually XM -- be able to charge a premium for video delivery? Probably not. A company like DirecTV (NYSE: DTV  ) can bilk RV and conversion van drivers with mobile content delivery, but XM and Sirius will never have that kind of breadth to give up for video.

That's OK. Even if the first batch of content consists of old cartoons in the public domain or cable network broadcasting deals, it will still be a value-added proposition. That is the kind of move that serves as the ideal lubricant in introducing a fee hike. Done right, it may also be the catalyst that leads to accelerating growth in satellite radio again.

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Microsoft is a Motley Fool Inside Value selection.

Longtime Fool contributor Rick Munarriz is a Sirius and XM subscriber, but he does not own shares in any of the companies mentioned in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. T he Fool has a disclosure policy.