Worst Stock for 2008: XM Satellite Radio

Resolve to keep your portfolio healthy: Help us pick the worst stock for 2008.

This time last year I picked XM (Nasdaq: XMSR  ) as my worst stock for 2007 because I just plain don't like companies that consistently destroy shareholder value.

In one respect I was wrong -- XM wasn't the worst stock. Many financial and real estate related companies easily beat XM in the lemming derby -- but the company hasn't disappointed me. Its stock continues to slide, losing 26% in 2007.

Normally I wouldn't be concerned about a one-year price drop, but the shares have now dropped 60% in the past two years, and I don't see any end to the pain that shareholders must suffer. Traders may make money on volatility, but shareholders can't win here.

Value destruction
XM is a growth company in all the wrong metrics except revenues. But revenues here do not constitute healthy growth because the inputs necessary to achieve that growth have been far too costly. The company has yet to make a profit and habitually dilutes shares outstanding and increases debt every year and as yet I can see no sign of that ending.

Ignoring these metrics is one critical error you must avoid in investing. When the only hope is merging with a company that destroys value just as much, Sirius Satellite Radio (Nasdaq: SIRI  ) , that is a poor excuse for an investment thesis -- that's speculation!

2001

2002

2003

2004

2005

2006

TTM

Revenues

$0.5

$20.2

$91.8

$244.4

$558.3

$933.4

$1,086.0

Net Income*

($307.5)

($515.9)

($604.9)

($651.2)

($675.3)

($731.7)

($706.8)

Shares

75.3

101.3

185.0

210.9

257.9

305.8

314.3

Total Debt

$413.4

$416.4

$781.9

$955.3

$1,043.2

$1,300.6

$1,487.2

Equity Value

$926.7

$592.3

$532.9

$336.2

$80.9

($397.9)

($789.6)

Source: Capital IQ, a division of Standard & Poor's.
*Net income includes dividends on preferred stock and premiums on preferred stock redemption.

Over the past five years share count has gone up by a compounded average 27% and debt by almost 30% per year. The decline in equity value is actually worse than it looks because there is a positive injection of new equity capital each year -- it's just that negative earnings and new debt swamp the equity additions.

A car beam of hope?
The hope for investors in XM and Sirius has always been that after years of negative profits, the benefits of Amazon-like (Nasdaq: AMZN  ) and eBay-like (Nasdaq: EBAY  ) network effects would kick in and turn the companies into cash-printing machines.

But even with the cooperation of major car manufacturers, neither one can turn a profit, nor in my estimation will they ever. Companies like General Motors (NYSE: GM  ) and Toyota (NYSE: TM  ) know only too well that they have XM over a barrel. Gross cost per new subscriber is now $116, up from $94 a year ago.

Against a monthly fee of $12.95, this would seem reasonable if the company could keep its subscribers for more than a year. In the third quarter, XM announced 952,000 gross subscriber additions, but only 315,000 net subscriber additions. I suspect that many car owners are, like me, willing to try satellite radio if it comes standard with the car and a few months free subscription but are not interested in paying when all we want is local traffic and sports news. For music they prefer their own brand via Apple's (Nasdaq: AAPL  ) iPod.

A merger to the rescue
Certainly the agreed merger with Sirius will help satellite radio and bring administrative costs down. Also, car companies and on-air talent won't be able to play one satellite company off against the other. Yet joining one value destroyer to another isn't likely to bring the enterprise to the promised land of profitability. The combined negative retained earnings are more than $8 billion, and it is likely that car manufacturers or some other large investor will end up owning all the equity to avoid bankruptcy.

I'm sure plenty of people have made money trading XM shares, and in my opinion that's the only way to make money here. But I'm not a speculator. Certainly no investor has made money, and for retail investors like you and me, the likelihood of making money is so remote it's much simpler to invest in any number of profitable companies on sale today.

If you also believe that XM will do poorly in 2008, head over to CAPS and rate the stock an underperform. Later this week, we'll reveal which stock has been selected by our readers as the worst stock for 2008.


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