There's nothing like the word "terrorism" to get people's attention. The folks at WorldSpace (NASDAQ:WRSP) know this all too well. The firm's recent IPO was covered by newspapers and magazines around the world, with most concentrating their attention on accusations that several of the company's financial backers have ties to terrorism, either through charitable contributions or business investments.
From where I sit, that's the least of investors' risks. We may never know if WorldSpace's sugar daddies are involved in anything as extreme as terrorism. But their financial interest in this company, as well as the huge risks facing this firm and its incredible appetite for cash, nearly guarantee that this stock will blow a large hole in your portfolio.
The new story
At first blush, WorldSpace might look like a no-brainer. We're talking about a Washington, D.C.-based satellite radio provider, akin to better-known peers XM Satellite Radio (NASDAQ:XMSR) and Sirius Satellite Radio (NASDAQ:SIRI). Founded in 1990 by current capo Noah Samara, WorldSpace actually helped launch XM and still has a variety of relationships with that firm.
WorldSpace has two satellites in geostationary orbit, AsiaStar and AfriStar. It boasts that it's the only licensed provider of digital audio radio service in Africa, Asia (minus Korea and Japan), and Western Europe. That's a lot of potential clients, folks -- perhaps five billion.
The real story
WorldSpace is still in the process of reinventing itself. Samara, the Ethiopian-born CEO, clearly set the delivery of news to the rural poor in Africa and Asia as one of the enterprise's goals. That's laudable, but it won't help profitability in a business that has yet to reap any profits at all. Samara seems to have realized this, since the former WorldSpace Foundation has changed its name. But First Voice International still gets 5% of the two satellites' broadcast capacity.
WorldSpace originally focused on Africa -- a continent where, south of the Sahara, annual per-capita income hovered around $500 in 2003. The firm subsequently decided that might not be the most lucrative market for a monthly pay radio service and turned its attention to India, where it already offers a $3.44-per-month subscription plan serving 27,000 subscribers. The company plans to expand into China and Western Europe.
Before you get too excited about all that "potential," keep in mind that in India, per-capita take-home is still only $540 per year. True, a class of more affluent workers earn about $37,000 a year, but they represent only 35 million households, according to WorldSpace -- a small fraction of India's huge population. Just remember that the real potential audience is very small compared to the "billions" that WorldSpace tosses out when addressing the pie-in-the-sky potential audience for its planned rollouts.
Are we there yet?
"Planned rollout?" you're asking. "I thought you said these services were already up and running." The truth is, they're only kinda-sorta up and running. WorldSpace's services work with their "portable" receivers, stuff that can be moved from place to place, but usually sits still. However, without a network of earth-based "repeaters," the company can't capitalize on the market that has provided American satellite radio with its best growth: "mobile" receivers that fit into automobiles or otherwise zip from place to place. Worse yet, WorldSpace's current generation of receivers won't work with its planned repeater broadcast system.
That's right. Unlike XM and Sirius, WorldSpace won't be able to piggyback on the upselling done by dealers hawking cars for Ford (NYSE:F), GM (NYSE:GM), or DaimlerChyrsler (NYSE:DCX). It plans to get to this point eventually, but doing so will require a lot more cash and -- in India -- possibly paying up to 4% of gross earnings in taxes.
In summary, WorldSpace not only has to develop and deploy more transmission infrastructure, but also come up with an entirely new line of receivers to work with that new infrastructure. In addition, it'll have to subsidize a swap for any previous users when it finally makes the switch, or else risk an exodus of disgruntled customers with suddenly worthless radios.
Had enough? Here's more. WorldSpace is still at the mercy of licensing and other oversight in China and India. The Chinese government will determine the price that can be offered in that country. On top of that, to complete its ambitious plan, WorldSpace will need to develop content in dozens of languages, an international sales and support infrastructure (in enough languages to service all those countries), and myriad other important systems.
Oh, and by the way, WorldSpace's satellites have already lived through about half their estimated useful lives. AfriStar is already gimped by bum solar power panels, which may force WorldSpace to reduce the number of channels it can send. (Anyone else wondering if that's part of the reason for the company's new focus on Asia?)
Burn baby burn
With all those major hurdles left to clear, you may be wondering why WorldSpace refers to its "development stage" in the past tense. So am I. I'd say that the real development is just beginning. And, truth be told, once you read past the fluff in the SEC filings, WorldSpace lays it out pretty clearly. Here's a telling snippet.
"We will need cash to cover the incremental roll-out of our India business plan, including the build-out of terrestrial repeater networks, accelerating service launch in key cities in India and marketing expenses related to subscriber acquisitions over the next three years. Furthermore, we will require additional cash to continue our business development activities in China and Western Europe, as well as for working capital and selling, general and administrative corporate expenses."
Translation: "We're going to burn a lot of cash." Elsewhere, management explains that it will need to sell stock and/or borrow money in order to keep the company running. No kidding.
In the past few years, the company has burned about $40 million a year in operations, and that's expected to increase substantially. The firm currently estimates that cash on hand will last a year or more. My bet is it goes even more quickly.
Who pays the bills?
By now, your antennae should be up. After all, isn't the whole point of an IPO to raise enough cash to run a company long enough to execute its business plan? Ah, Grasshopper, that was the way of the world in times past. Today, the IPO is an exit strategy for the folks who got on board first -- not that you can blame them for wanting to get off this ride.
Since startup, WorldSpace has succeeded in burning through more than $2 billion, and it's become pretty clear that the company's previous funders don't want to put more of their own money on the line.
So who better to hit up for a quick cash infusion that the gullible public markets? WorldSpace's IPO was expected to raise about $250 million. The shares, priced at $21 for the offering, crested at $24 on the first day of trading. They've already dropped to $18, giving the firm a market cap of something around $400 million. If you ask me, they deserve to go for a lot less than that, and not just because this valuation currently prices the firm at 45 times 2004's sales of $8.6 million. WorldSpace lost $577 million in fiscal 2004.
Back of the line, you
Assuming that there are profits down the road, anyone who buys shares of WorldSpace on the market today is relegating himself to a seat at the very end of the line when it comes to collecting. Samara's ownership interest grants him complete control over the entire company. Don't think he's earning his $650,000 per year salary (plus up to a 95% bonus and $2.5 million of options grants per year)? Tough luck, buddy. He picks the guys who pay him.
It gets worse. WorldSpace's prior benefactors are in the front of the line. They don't even have to wait for real profits in order to get paid. Much of WorldSpace's previous money-to-burn came from two Saudis, Mohammed H. Al Moudi and Khalid Bin Mahrouz. Most of their interest in the company has since been moved into a Cayman Islands company called Stonehouse. They used to hold a billion in debt, but now they've got a solid lock on any potential profits, even if there are no real profits for the rest of the investors.
That's because Stonehouse will get a royalty of 10% of EBITDA until the end of 2015. You read that right. That's earnings before interest, taxes, depreciation and amortization, Fools. Since WorldSpace has already told outside shareholders that its shares will be diluted like crazy, investors buying them now are guaranteed to see their proportion of any eventual proceeds shrink. Meanwhile, the Stonehouse crew keeps a constant share, to be paid in cash. And finally, the terms of the royalty agreement actually give Stonehouse a claim on WorldSpace's assets. They get to have their cake and eat it too.
Sweet deal for them. Not so good for you.
The Foolish bottom line
WorldSpace may look like the next big thing, but its very survival is in question. Even if it manages to sell a lot of its service in the marketplace, current investors are going to have to endure long periods of losses while the well-connected insiders pay themselves first. The smart money here looks like a short, or no position at all.
For related Foolishness:
- Rick Munarriz wonders whether WorldSpace is the next hot satellite radio stock.
- David Gardner recently interviewed XM CEO Hugh Panero.
- Maybe traditional radio won't die without a fight.
- Talk shop with sharp Fools who know the sector well in the XM discussion board.
Seth Jayson couldn't bring himself to read the entire 1,200 page registration statement, so he suspects there are more creepy delights waiting to be discovered. At the time of publication, he had positions in no company mentioned here. View his stock holdings and Fool profile here. Fool rules are here.
