With barriers to its drawn-out merger with Sirius Satellite Radio (NASDAQ:SIRI) mounting in the form of Federal Communications Commission concessions, it's refreshing to see XM Satellite Radio (NASDAQ:XMSR) take the right steps in improving as a standalone company.

The largest satellite radio provider narrowed its deficit during the second quarter, posting a loss of $0.38 a share. The bottom line showing is better than both the $0.57 a share it surrendered a year earlier and the $0.41-a-share loss that Wall Street was expecting.

Cynics may scoff at a narrowing deficit over actual profitability, but let's go over why XM gets a passing grade for the period:

  • Subscriber acquisition costs fell.
  • Churn fell.
  • Conversion rate, essentially the number of car owners who keep paying for the service after their free trials run out, rose to 53.4%.
  • With nearly 9.7 million subscribers during the period, the company gained a net base of 322,000 subscribers during the three months.
  • Automakers are still loving XM, giving XM its fifth consecutive quarter of record additions on that front.

This doesn't mean that XM passes with flying colors. Revenue inched just 15% higher to $318 million. Mr. Market was looking for a 17% spike on the top line. Subscription revenue per subscriber took a small dip, which is normal as consumers take advantage of XM's plan that offers additional radios in the same account at a discount. However, advertising revenue also shrank on a per subscriber basis. Yes, one of the strongest attractions to satellite radio is commercial-free music, but XM has a ton of ad space to sell on many of its other stations.

The challenge of incremental revenue
I realize that the ad market is softening, but satellite radio offers the juiciest of demographics for marketers -- consumers with the ability to pay as much as $13 a month for premium radio -- and it should be able to cash in on that, for far more than the $0.37 it is averaging a month per subscriber. It can't help that whenever I'm listening to XM, it seems as though I'm hearing the same spots over and over again.

The last thing that premium radio subscribers want is to step under a deluge of audio ads, but where's the harm in having companies sponsor channels or shows? Even a simple "brought to you by" snippet at the top of every hour on a music channel wouldn't eat into the playlists.

Satellite radio has many revenue streams to paddle in. I was pumped when XM hooked up with Napster (NASDAQ:NAPS) three summers ago. In a single day, XM announced a compilation CD deal with Starbucks (NASDAQ:SBUX) and the deal with Napster, allowing music fans to order the tunes they hear on the air as a digital download through Napster.

XM spit out Starbucks earlier this year. The deal was actually more costly than incremental. However, you don't hear a whole lot about XM's efforts to further monetize its programming. XM has rabid music fans with enough discretionary income to pay for radio. One would think they also would be open to buying CDs, DVDs, and concert tickets through XM too, especially since it has become a prime source for music discovery and artist-related news.

And what about the XM website itself, especially as more members take advantage of the included online streaming service? Subscription-based Internet companies typically shy away from wallpapering their sites with ads. Even the mighty Netflix (NASDAQ:NFLX) gave it a shot two summers ago, only to abandon its banner ads a few months later. However, incorporating third-party ads seems to be doing just fine on eBay (NASDAQ:EBAY), despite seller criticisms that potential buyers are being lured away. XM only needs to worry about advertising subtly enough, so as to not turn off its subscribers.

Act as if
It's not a surprise to see XM relatively quiet in drumming up incremental revenue streams since the Sirius merger was announced 17 months ago. Partners are hard to win over if there is continuation of uncertainty post-merger.

However, have you seen the hoops that XM and Sirius will have to jump through to get the deal cleared? Can XM and Sirius thrive under an environment where they will have to freeze rates, regardless of percolating programming costs, for years? Is it still worth it to go through the merger if the FCC mandates that public interest programming make up a significant chunk of the content and that receivers also include chips for terrestrial's HD Radio salvo? There will come a point where the concessions make it too hard to swallow, prompting Sirius or XM to walk away.

XM needs to be ready to walk, talk, and rock as a standalone company. It is something that may not have seemed so important over the past 17 months when it had Sirius to lean on, but times are changing.

This brings us back full circle to the company's quarterly results. It was a good report, but XM needs to get back in touch with its fledgling retail business. A couple of years ago, XM receivers were flying off the shelves at consumer electronics superstores. Now, XM is relying mostly on factory installations through automaker partners like General Motors (NYSE:GM).

That needs to change. On the retail end, XM lost 38,000 more subscribers than it gained during the period. Naturally a big reason for this is that XM -- and Sirius, too -- have been scaling back their marketing budgets ahead of the merger. Well, it's probably a good time to begin selling Brand XM again.

As long as XM keeps taking steps, even if they're baby steps, in the right direction, XM will be in that much better shape as it tackles radio alternatives, debt, and deficits.    

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