FOOL ON THE HILL
Siriusly Toxic

Sirius has been widely supported by Wall Street analysts, despite the dismal story told by the company's business fundamentals. For the contrary investor willing to snub the Street and do independent research, ignoring the sell-side consensus and focusing on the financials can lead to profitable situations.

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By Zeke Ashton
July 25, 2002

If you read the Rule Breaker column here at the Fool, you probably know that back in January the Breaker Portfolio managers made a smart investment decision -- to sell short Sirius Satellite Radio (Nasdaq: SIRI). Readers of the Motley Fool Select were treated to a full overview of the satellite radio industry in the January 2002 issue, in which Select questioned whether there would be enough of a market for satellite radio to support both Sirius Satellite and its (better) competitor, XM Satellite Radio (Nasdaq: XMSR). At the time, Sirius Satellite was selling for $6.90 per share.

Let's review. Sirius is the number two player in the nascent market for satellite radio, behind XM Radio. Sirius has managed to put three orbiting satellites into space and has a network of terrestrial repeaters. Its state-of-the-art studios in New York City broadcast 100 commercial-free channels of digital-quality radio, mostly to motorists, for $12.95 per month. The company launched its service in four test markets in February and announced the availability of its services on a nationwide basis on July 1, 2002.

Sirius has agreements with major stereo manufacturers for its Sirius-ready radios, and big auto makers such as Ford (NYSE: F), DaimlerChrysler (NYSE: DCX), and BMW are set to install the radios in new car models.

Ignoring the Wall Street hype
After my own review of the company's financials, I shorted Sirius myself. But by that time it was March, and the stock was around $5. Today, it's trading around $2 and change.

Why did this particular short work out so well? Sure, part of it is because the market has taken a beating this year -- the Nasdaq's down more than 35% for the year. But even more than that, I'm convinced it was because the Wall Street hype machine has continued to support Sirius with sell-side research reports that paint far too positive a picture of this company's prospects.

Using www.multex.com, I reviewed the Wall Street research reports on Sirius dating back to August of last year. Proving that I'm not the only one who can come up with a pun on Sirius, Ladenburg Thalman initiated coverage of Sirius with a report noting the company's "Sirius potential" and offering a $42 target price for the stock in August of 2001. Deutsche Bank Alex Brown has consistently maintained a "target price" for the stock well in excess of the market price.

Select quoted a Deutsche Bank Alex Brown projection for 8.4 million satellite radio subscribers by 2005. It should be noted that at least Deutsche Bank doesn't continue to have a "buy" or "strong buy" rating on the stock -- it has a "market perform," as of March 27, though it did maintain a target price of $9.

As of Feb. 20, Robertson Stephens rated Sirius a "buy" with a $7 price target when the stock was at $4.89. But it's Lehman Brothers analyst William Kidd who has been most supportive of this stock. In fact, he still rates Sirius a "strong buy," though he has reduced his price target from $15 on June 24 to $9 this past week. Why is Lehman Brothers so high on the stock? Surely not because Lehman owns $150 million in Sirius debt, which came with a ton of warrants to purchase Sirius stock?

An ordinary investor willing to ignore the sell-side fluff would've come to the conclusion, within an hour, that this company is likely to hit zero. In fact, let me say here and now that I rate this stock "toxic," and hereby establish a 12-month price target of $0.09 and two Cheerios box tops. Why? Let's look at the numbers:

The financial statements tell all
I finally cracked open the Sirius 10-K for 2001 back in late March. Here's what I found:

• Since the company's inception in May of 1990 through the end of 2001, Sirius has spent $939 million in capital expenditures and has experienced aggregate net losses of $505 million.
  
  
• The company lost $241 million in 2001, which included $58.4 million in engineering design and development costs, general and administrative costs of $95.9 million, and interest expense of $89.7 million. Cash from operations was a negative $148.8 million, and capital expenditures were approximately $81.3 million. As of December 2001, Sirius had total debt of $672 million and shareholders equity of $323 million. The company's cost of capital is frighteningly high, with $242 million worth of 15% discount notes due in 2007, and $176 million in 14.5% notes due 2009. Additionally, $150 million of that debt is in the form of a term loan with Lehman Brothers, which contains various covenants that, if not met, could result in a demand by Lehman for accelerated repayment of the loan (a demand that would likely also trigger accelerated repayment by the other Sirius debt holders).

Then I looked at the first-quarter 10-Q.

• In the first quarter of 2002, Sirius burned through another $117 million in cash from operations, plus $11 million in capital expenditures. Since the company didn't launch the service in test markets until February, subscriber revenues were only $4,000 for the quarter. Meanwhile, competitor XM has now signed up 136,000 subscribers as of June 30 (though that company is burning cash at an alarming rate as well). Sirius ended the first quarter with approximately $400 million in cash.

Here's the bottom line on Sirius: The company will run out of money by the first quarter of 2003, at the latest. It will need $300 million or so to get through 2003, then at least several hundred million after that to reach profitability.

In 1999, it could have happened. Not now. No matter what Wall Street says, this stock is going nowhere but down.

At the time of publication, Zeke Ashton was short Sirius Satellite for the reasons detailed above. Or maybe it's because of the 10 commercials for XM Satellite Radio he hears every day driving from his house to 7-11. The Motley Fool has a disclosure policy.