Fool on the Street: Fine Tuning at XM

These are pretty rewarding times for XM Satellite Radio (NASDAQ:XMSR) investors. Really. Sure, the stock is well off the all-time high it set just before the 2004 holiday season. However, the shares have soared 40% higher since bottoming out two months ago. That's a pretty impressive run for a company that was floundering earlier this year, when it was being attacked by everyone from the FCC to the RIAA to even a bolting director.

Chairman Gary Parsons spoke at the Goldman Sachs Communacopia conference yesterday. After all that XM has been through lately, it was a great time to get the company's story out there for others to hear.

Time to get Sirius
Even though Parsons began by waxing positive on the satellite industry as a whole, singing the praises of its heady initial growth relative to other innovative gadgetry like cell phones and DVD players, he quickly turned his attention to Sirius Satellite Radio (NASDAQ:SIRI).

XM is larger than its rival. Recently topping the 7 million subscriber mark, the satellite-radio pioneer has a 2 million-subscriber lead over Sirius. The problem for XM is that Sirius has been closing that gap over the past three quarters on the retail-market strength of its Howard Stern acquisition. Then again, that alone shouldn't justify Sirius' larger market cap.

Parsons would agree. He also thinks XM is being slighted in the market despite having some other advantages over its rival.

"We add more gross additions every quarter at virtually half the price as our competitor," he said. "Our programming costs on a per-subscriber basis are dramatically lower than our competitor."

Yes, that dreadfully high cost to acquire new subscribers has stung both players. When companies are toiling away in red ink, skeptics point to costly marketing campaigns and subsidized hardware, but they ignore the exceptional growth prospects. It's happening to XM and Sirius. The same overblown fears are also likely keeping shares of TiVo (NASDAQ:TIVO) in the single digits.

Those bearish guns are worth disarming if you're a bull on XM. Parsons is, of course. He points out that the company is trying to keep its cost per gross addition to $100. That seems high, but the typical new account also provides an average of $90 in prepaid cash up front.

An eye for the iPod
He challenged those in attendance to come up with subscription models that offer a better cash-on-cash recovery from the onset. The cynic in me would have offered up the $499 lifetime-subscription plan that Sirius offers -- or the TiVo lifetime offer that was put to rest earlier this year -- but this isn't a time to play the killjoy. If it had been, I would have tackled the early-adoption rate as well. Apple Computer (NASDAQ:AAPL) introduced its iPod a few weeks after XM began selling its receivers, yet it's managed to move 60 million iPods in five years.

The iPod came into play later in the conference, when a Goldman Sachs analyst asked about the claim that supposedly 70% of all 2007-model cars will come with iPod interoperability. Parsons thought the figure was high, but he wanted to clarify that this simply means a plug-in jack will be available, essentially to compensate for the phasing-out of cassette players in cars. Early systems relied on the car's tape deck to stream an iPod through a car's speakers.

Enhanced features like HD radio and iPod interoperability are coming from XM, but Parsons sees it as "a real struggle because there is no effective way ... to actually compensate the car companies to influence putting it in, and it's difficult to put that compelling mix together." He's right, of course. A car dealer has little incentive to push a satellite-radio system, since its recurring royalty stream goes entirely to XM or Sirius.

On the other hand, I know I'm not the only one who has both an iPod and satellite radio. I don't find them to be interchangeable. If I want to hear fresh content, streaming my digital download collection on my iPod scratches an entirely different itch.

Two parts beat as one
Parsons also addressed the industry-consolidation rumors. He is on record as saying that consolidation in most situations allows for certain synergies, but he believes that the touted advantages of an XM-Sirius hookup are overblown.

In pointing out that the Sirius model has things that are "structural and built in contractually into the cost structure," Parsons noted that there are a lot of operating expenses that can't simply be hacked off to take advantage of economies of scale. One can also only begin to fathom the regulatory upheaval that would be caused by a duopoly bent on becoming a monopoly.

We can also wonder whether the corporate combination is even necessary at this point. Both companies continue to close in on producing positive cash flow on an operating basis. Oprah Winfrey's arrival on XM should help its efforts on the retail front. You also have two stocks that have bounced back since bottoming out in late July. Sure, Sirius is up just 10% in the same time that XM has surged 40% higher, but that may be part of the valuation rebalancing.

Despite the lowering of its year-end subscriber targets and the expected softness in the current quarter, investors appear ready to listen to the XM story. Parsons loves to tell it.

XM is an active recommendation in theRule Breakersnewsletter service. You're welcome to swing away at Rick with a free 30-day pass to access all of the newsletter's content services including a lively subscriber-only discussion board. TiVo is aStock Advisorselection.

Longtime Fool contributor Rick Munarriz has been a Sirius satellite subscriber since 2004 and an XM subscriber since this spring. He does not own shares in any of the companies in this story. He is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.The Fool has a disclosure policy.