OK, so I had inside info on this upcoming Duel a couple of weeks ago. I didn't trade on the information, so please don't sue.
I'm taking the bull side for Sirius Satellite Radio (NASDAQ:SIRI) in this argument, and my reason is very simple: valuation.
Sirius has two big strikes against it in the game of baseball trading that is the stock market. First, its business model strikes some investors as untenable, with or without a larger competitor in XM Satellite Radio (NASDAQ:XMSR). Satellite launches are expensive, and these guys are competing with essentially free FM and AM radio, among other rivals.
Second, the proposed merger between the two satellite radio operators looks shaky when you consider comments from senators and FCC bigwigs involved in the antitrust evaluation process. The market does not like uncertainty at all, and along with the basic skepticism, this is a lethal double play that keeps the stock price close to the plate.
No, sir, away!
So let me lift the fog of mystery around this company a little bit. Let's start with the expensive business model.
Yes, launching hardware into orbit costs a lot of money. The cost lingers on income statements for years in the form of depreciation and amortization charges, as well as interest payments on the loans used to finance these infrastructure upgrades.
But you'd be surprised at how little those charges move the needle for Sirius these days. In the latest quarter, for example, depreciation costs landed at $26.8 million and net interest expense was $9.2 million. That's $36 million of charges, a rather small part of the $144.8 million net loss. Satellite and transmission expenses amounted to just $8.0 million in that period.
No, the real cash sink here is the marketing machine that drives in new subscribers by the bucketful. To that end, I'd count $38 million of sales and marketing, a cool $100 million for subscriber acquisition costs, $27 million of revenue-sharing deals and royalty payments to automakers and equipment manufacturers, and $60 million of content and programming costs.
All of those items are meant to add to the subscriber base. Much like the classic Netflix (NASDAQ:NFLX) -- and current Blockbuster (NYSE:BBI) -- model, or that of audiobooks maven Audible (NASDAQ:ADBL), Sirius has the option to take its foot off the accelerator pedal at any time and start making money. It's just that right now, the industry is in its explosive-growth infancy, and the company chooses to invest in its own future.
A papaya war is on!
As for the merger-related miasma of uncertainty, you might as well just assume the worst. That is, act as if the deal won't happen. It's clear that the combined entity would save a lot of money on a unified marketing strategy as opposed to battling each other for consumer acceptance. Also obvious is the greater pull of a single platform compared with a choice between two incompatible yet seemingly similar ones. VHS/Betamax, anyone? HD-DVD vs. Blu-Ray?
But even in a fragmented satellite radio market, I say Sirius and XM could do just fine. Compare the radio market anno 2007 with television circa 1997: two satellite-based providers facing a sea of entertainment and information alternatives, including the growing Internet and essentially free over-the-air broadcasters. The satellite TV duo is doing just fine 10 years later. EchoStar (NASDAQ:DISH) stock has grown an annualized 35% for a decade, giving 1997 investors more than 20 times their money back.
That's a solid home run. Don't miss the next one.
The duel's not done yet! Go back and read the other arguments, then sound off in Motley Fool CAPS and vote for the winner.
Netflix is a current Motley Fool Stock Advisor recommendation. Trials! Trials! Free 30-day trials here for everyone!
Fool contributor Anders Bylund is a Netflix shareholder but holds no other position in any of the companies discussed here. He loves palindromes -- spot the hidden one in this story. You can check out Anders' holdings if you like, and Foolish disclosure is coming at you in brilliant digital purity anywhere you want it.
