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Martian Chronicles
For Consideration: XMSR

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By crschoen
May 1, 2003

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I thought I would post my first attempt at a stock write-up. I've been following this stock for only about a month, and have yet to purchase any shares. Unfortunately it has gone up about 50% since I first looked at it. I have refrained from purchasing any because I still feel like I need to do some more DD. I thought maybe the write-up would help me in that regard as well as running it by more experienced investors.

Background

XM Satellite Radio is a nationwide provider of audio entertainment and information programming for reception by vehicle, home and portable radios. Their digital audio XM Radio service offers 100 channels of music, news, talk, sports and children's programming for a current monthly subscription price of $9.99; they also offer one premium channel.

They transmit the XM Radio signal throughout the continental United States from their two satellites "Rock" and "Roll." Approximately 85% of revenues are derived from subscriptions, with the remaining portion coming from ad revenue and royalties.

Growth potential

As of Dec. 31, 2002, they had 347,000 subscribers, compared to 28,000 at Dec. 31, 2001. Revenue from subscribers consists of subscription revenue, activation revenue and equipment sales. Subscriber related revenue was $17.6 million for 2002, compared to $246,000 for 2001. Average monthly subscription revenue per subscriber (ARPU) was approximately $9.43 during 2002, and $8.57 during 2001.

The Yankee Group projects satellite radio will achieve 15 million subscribers by 2006 (May 2002 study) and market studies conducted for us project that as many as 49 million people may subscribe to satellite radio by 2012.

XMSR hopes to achieve the 1 million-subscriber milestone by 2003. Although some analysts are more optimistic and project subscriber growth to 1.2 million by year's end. XMSR recently negotiated a deal with General Motors in which they will install XM radios in 75% of their models this year. Smaller deals are in place with Toyota and Honda.

An interesting press release today announced that XMSR will market a satellite radio receiver for personal computers.

Business economics

I believe one compelling quality of their business model is that the incremental cost of adding new subscribers is very low. The added revenue will increase margins and hopefully drop to the bottom line.

Cost of revenue includes costs of radios associated with radio sales, revenue share & royalties, customer care & billing costs, satellite & terrestrial operating costs, cost of broadcast and operations and programming & content. These combined costs were $118.6 million for 2002, up from $107.7 million in 2001, and increase of $10.9 million or 10.1%. This compares favorably to the huge growth in subscriptions for 2002. Satellite & terrestrial includes: telemetry, tracking and control of our two satellites, in-orbit satellite insurance and incentive payments, satellite uplink, and all costs associated with operating our terrestrial repeater network such as power, maintenance and lease payments. These expenses were $44.8 million in 2002, compared with $62.6 million in 2001, a decrease of $17.8 million or 28%.

Competition

Sirius Satellite Radio (SIRI) is the main competition. However I believe that Sirius has not made the same progress as XMSR, and consequently, XMSR will emerge as the dominant player.

Valuation

Valuation is what you would expect with a start-up company. With the recent run-up in the stock price, the growth potential has already begun to be factored into the market value. With total revenue of $20 million for 2002 and current market cap of $945 million, it is trading at almost 50 times last years revenue.

Using the company's target of 1 million customers and ARPU of $9.43, we could estimate that they could have revenue of $9.43 million per month at year's end. This would translate to a slightly more reasonable valuation of 9 times projected 2003 revenue.

Liquidity

The main concern with XMSR has been their liquidity. Perhaps they went public too quickly, but at any rate, they have recently had to finagle some key financing and vendor agreements in order to remain solvent. They seem to have staved off a current liquidity crisis, but perhaps at the sake of substantial dilution to shareholders in the future.

The 2002 10-K lists $567 million of total liabilities, which included $325 million of 14% senior secured notes. 2006 might present liquidity problems as $142 million of debt comes due. However this information is a bit dated in light of some recent financing deals. One example:

On January 28, 2003, the Company completed (1) an exchange of over $300 million of the $325 million aggregate principal amount of outstanding debt issued by XM Satellite Radio Inc., (2) a restructuring of $250 million in payment obligations to General Motors Corporation through 2006, and (3) a private placement resulting in gross proceeds to the Company of $225 million. The Company accepted for exchange $300.2 million aggregate principal amount of the previously outstanding $325.0 million of XMSR's 14% Senior SecuredNotes due 2010. For each $1,000 principal amount of notes tendered for exchange, the tendering holder received: $1,459 principal amount at maturity of 14% Senior Secured Discount Notes due 2009 issued by XM Satellite Radio Inc. and guaranteed by XM Satellite Radio Holdings; a warrant to purchase 85 shares of the Company's Class A common stock at an exercise price of $3.18 per share; and $70 in cash. The exercise price of each warrant may be paid either in cash or without the payment of cash by reducing the number of shares of Class A common stock that would be obtainable upon the exercise of a warrant. The warrants are fully vested and expire December 31, 2009.

Other Risks

The company seems to have a number of future obligations that could substantially dilute current shareholders. There are also a number of warrants that Sony and CNBC hold that might cause shareholder dilution in the future. Anyone interested in this company should carefully review all the terms of these warrants and the convertible debt instruments held by various parties.

Other risks would include the problems with the auto industry (i.e. subscriptions are driven by new car sales), competition from Sirius, and satellite malfunctions and defects.

Conclusion

I think this is an interesting, albeit risky speculation for a start-up company with high growth potential. For those who can keep an eye on developments, and can handle the risk, it might be an interesting portfolio allocation.


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