2006 in Review: XM Satellite Radio

It wasn't the best of years for XM Satellite Radio (NASDAQ:XMSR). Yes, the company made strides towards becoming an operating cash flow company, signed up a potential demographics-stretching magnet in Oprah Winfrey, and kept adding to its net subscriber count.

Unfortunately, all that was offset by mounting losses on a larger share base, weakness in retail sales even after Oprah's arrival, and subscriber forecasts that were hosed down three times over the course of the year.

In the first quarter, XM posted a wider March period deficit than it did a year earlier. Thankfully, the company was able to rein in the subscriber acquisition overhead that had plagued the company during the holiday quarter of 2005. Back then it didn't have much of a choice. Rival Sirius (NASDAQ:SIRI) was making all of the industry headlines, with Howard Stern bidding terrestrial radio farewell, and XM had to ramp up its marketing campaign.

Even though the April quarter would mark the second straight quarter in which Sirius would have landed more net new subscribers, XM was still growing nicely. The top line had more than doubled and the company was looking to have 9 million subscribers by year's end. Unfortunately, the subscriber growth rate was decelerating. The satellite radio leader's net subscriber growth clocked in just 5% higher than the 541,140 accounts that it had signed up in the March quarter of 2005.

In the second quarter, cracks in the XM machine became glaringly -- and blaringly -- obvious to the market. XM found itself battling several demons, despite an 82% top-line spurt. There was an FTC investigation, insider selling, a board member resigning as he warned of "chaos" on the horizon, and a battle with the music industry over royalties.

Remember that 9 million member target from April? It became 8.5 million in May, before being taken down another notch -- to a range between 7.7 million to 8.2 million -- in July's report. That was practically a given. "Anyone with a calculator and a penchant for train wrecks can see that XM may let us down one more time." I wrote that weeks before the report, after adding up each company's year-end projections and realizing that XM would have to somehow regain the new subscriber acquisition lead from Sirius (which didn't seem likely).

In the third quarter, XM finally gave investors a few reasons to be grateful. Net loss narrowed by 36% to $84 million. Growth continued to decelerate, yet revenues still soared 57% higher to $240 million. Yes, it wouldn't be an XM quarter without lowering the bar on the newbie front -- the year-end goal was dropped to 7.7 million to 7.9 million -- but at least the company wasn't flinching in its longstanding objective to produce positive cash flow on an operating basis in the final quarter of 2006.

XM, in a nutshell
Overall, XM has had a pretty crummy year, but it is one that is closing on a more upbeat note than the dirge that the satellite radio giant was playing earlier on. The chart tells the tale. XM shares began the year priced at $27.28 a share and had dipped into the single digits by the summer.

The company has rebounded strongly off its July lows, though. Since then, XM's stock has climbed 65% higher. That allowed the Motley Fool Rule Breakers newsletter service to recommend a sale on the stock last month, without feeling the same kind of sting that it would have felt if it had bowed out with the pessimists five months ago.

But what does the future hold? Well, our Motley Fool CAPS community members have something to say about that. Just take a look at how the overall sentiment stacks up:

Even though the bulls are narrowly edging out the bears, CAPS players are used to more convincing bullish polls. This tags XM with a one-star rating, the lowest possible rank in the CAPS stock rating service. Think otherwise? Let us know.

The bulls and bears are pretty vocal in CAPS. "In a world where consumers are being nickeled and dimed to death by cutting-edge, must-have technology (e.g., cell phone service, broadband service, cable service, VOD, wireless service for email and games, etc.), pay radio is going to lose," Hukphinn wrote. "There are simply too many 'free' alternatives (radio, iPod/MP3, CDs) that can satisfy most people's music needs well enough." CAPS player jjlandry6a counters that "XM is superior in product, sound quality, programming and customer support."

Wrapping it up
We are at a critical juncture here. We already know that the growth will come at a slower pace. The company started out the year with 5.9 million subscribers and expected to close out 2006 with more than 50% more listeners. That will now apparently be just 30% to 33% in net new subscribers.

Hitting positive operating cash flow will be a welcome sign, but keep in mind that the company will still be far, far away from profitability. It costs a lot to service debt, and those satellites don't come cheap (XM just launched its fourth satellite and will shortly begin prepping its fifth).

The stock has some favorable momentum going, thanks to speculation that it will merge with Sirius, or possibly even a big media partner like CBS (NYSE:CBS) or News Corp. (NYSE:NWS), but investors need to buy into the XM story as a standalone situation -- and that's a future as challenging yet potentially promising as its past.

I should know. Last year I was not only a subscriber to both satellite radio services, but also the one that recommended shares of XM to Rule Breakers growth stock subscribers. Was I too early? Was I too late? Until XM regains its luster and begins acting like a market leader, last month's sell recommendation isn't haunting me.

Check out the other companies featured in "The Motley Fool's 2006 in Review and 2007 Preview" special.

Longtime Fool contributor Rick Munarrizhas been a Sirius satellite subscriber since 2004 and an XM subscriber since this spring. He does not own shares in any of the companies in this story. He is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has adisclosure policy.