Three satellites are orbiting over our country right now and they belong to a company that we're going to sell short: Sirius Satellite Radio (Nasdaq: SIRI). (Selling short means we're speculating that the shares will decline in value, and we hope to profit from a decline.)
If you've picked up a business section of the newspaper the last few months, turned on CNBC, or visited the car radio shelves at an electronics store, you've probably seen the rising excitement surrounding satellite radio. That's because one of the country's two satellite radio providers, XM Satellite (Nasdaq: XMSR), launched its national service on November 12, 2001.
XM Satellite is nearing 40,000 subscribers while Sirius, despite its satellites in the air, is still waiting to get off the ground. Sirius once had a lead-to-market over XM (it went public in 1994 while XM IPO'd in 1999), but chip-set design problems with Lucent Technologies (NYSE: LU) made Sirius delay its product launch several times. Finally, Sirius' founding CEO left the company in a huff last fall.
Sirius now hopes to launch services in four areas (including Denver, Houston, and Phoenix) on February 14 and nationwide on August 1. By then, competitor XM's service will have been available nationwide for nearly nine months. XM is expected to end the year with 300,000 to 400,000 subscribers. The expectation for Sirius is to end the year with around 200,000.
What is satellite radio?
Satellite radio is broadcast from satellites to subscribers with satellite-ready radios (which cost $250 to $1,000, on top of a $70 antennae). The government granted two satellite radio broadcast licenses so far. They were sold to XM and Sirius for more than $80 million each. XM and Sirius each operate about 100 radio studios and pump out original programming (music of all kinds, talk, sports, etc.) and repackaged programming (CNN, NPR, ESPN, and more) to subscribers only.
Beyond program variety, the beauty of satellite radio is its clarity of sound, fewer commercials, and the ability to listen to the same station anywhere in the country.
When you decide to subscribe to satellite radio, you need to choose between an XM-compatible radio or Sirius-compatible. The two are not interchangable, and as we've seen in the past, one consumer technology format usually ends up burying its competitor (remember Beta?). Sirius and XM plan to co-develop a dual-system radio by 2004, but by then it may be too late for one of them.
Subscribers to satellite radio pay $9.99 per month for XM, and will pay $12.95 per month for Sirius. For those who dislike math, that's $120 to $155 per year (plus hardware costs and activation charges). "For radio!?" you exclaim. "But I receive plenty of stations free of charge!" Therein lies the largest marketing challenge for these two cost-heavy radio providers.
How large is the market?
The most optimistic projections have one-in-seven Americans subscribing to satellite radio before the decade ends. We find that pie-in-the-sky, but let's stick to just the next few years.
Both companies estimate that they'll need four million subscribers to reach cash flow positive (which isn't the same as profitable) and both aim to hit four million by the end of 2004. Both will not. If both companies sign four million subs in less than three years, for eight million total, satellite radio would be the fastest adopted technology to ever hit America -- faster than the Internet grew in the mid-90s, faster than broadband Internet, faster than cable TV, faster than satellite TV.
In our view, one company is going to fall far short of cash flow positive or break-even results by 2004, while the other company will likely draw a large lead in the market. If such a lead becomes evident, the second-place company will likely find its funding dry up at the same time that revenue from subscribers falls short.
Did we say "funding"? Sirius and XM are cash-burning machines. Sirius already has $640 million in long-term debt, and as of September 30 it had $340 million in cash while it burned $52 million that quarter. On January 3, Sirius announced plans to raise $158 million in a stock offering priced at $9.85 per share. Both companies must raise more funds next year, and perhaps again the year after that, for a bare minimum of $300 million each in new funds.
Why short Sirius?
Management at Sirius downplays XM's early lead, but we don't. XM is grabbing many of satellite radio's early adopters, and the excited early adopters are more likely to talk about the service to others. XM has a better branding strategy, too: You have AM, FMï¿½ and now XM. XM also costs $3 less than Sirius per month, while the channel offerings seem about equal aside from Sirius offering NPR, which carries Fool Radio, and the fact that Sirius will air fewer commercials on many channels.
We believe there's a good chance that XM will continue pulling away from Sirius (the current lead is approximately 40,000 subs to 0). If so, then aside from current investors that include Ford (NYSE: F) and DaimlerChrysler (NYSE: DCX), Sirius may find attractive sources for additional funds lacking. And even if funding comes easily, funding won't make operations profitable if Sirius doesn't have enough subscribers. (At the same time, we don't care to buy XM partly because just reaching four million subs in three years will require new adoption-rate records.)
So, what we predict is a long, tough road that includes a heated, expensive battle for subscribers between these two companies (the early adopters are easy to sign -- it's getting Ma and Pa America onboard that's the challenge); costly upkeep of studio programming, satellites and signal repeaters on the ground; the repeated need for more funds that will dilute shareholders and add more debt; and years until any real profits are made. Meanwhile, Sirius sports an enterprise value of nearly $800 million after soaring from $2.20 per share to above $10 in November, mainly on XM's product launch, before settling to today's $7.50.
Shorting is not for most
The Rule Breaker Portfolio is a high-risk portfolio for advanced investors. We don't short stocks lightly, and neither should you. As we wrote in The Motley Fool Investment Guide, when we do short stocks we typically aim for a 20% gain in about two to three months. Because it is done on margin, shorting is not usually a long-term endeavor. (Our short of Trump Hotels & Casino Resorts (NYSE: DJT) turned out to be an exception, and Sirius might too, but we're not shorting with that plan.)
On the upside, we'll treat Sirius as we did Trump when it rose: If the business outlook hasn't markedly improved, we're likely to wait out a stock rise. At one point, Trump rose 40% on us (so we were down 40%), but being diversified we were able to stick to our conviction that the business was weak, and eventually the short fell well in our favor.
We'll place an order to sell $17,500 worth of Sirius short (less than 5% of our port's total value) in the next five trading days.
You can learn more about shorting stocks (and how very risky it is) on the Fool, or pick up The Motley Fool's Investment Guide. To learn much more about satellite radio and its two competitors, grab this month's issue of Motley Fool Select. Satellite radio is looked at in the January issue with a 3,500-word report that can make arguments not made here; other topics include online retail's revival and one Rule Maker and one small-cap stock worth considering.
In closing, Sirius, we don't want you to falter, but after a 250% stock rise and as XM lands customers you could have had, we believe that your stock could trade lower in the coming months, while over the long term we question the market potential of two satellite radio providers. (That said, we also realize that Sirius could rise as its February 14 partial service launch approaches, while yet another delay would be harmful to investors. The stage is set. We know the risks.) Fool on!
The Rule Breaker managers don't hold any positions in stocks mentioned in this report. The Fool has a full disclosure policy and announces its portfolio trades before it makes them.