Have you tried satellite radio? If not, chances are someone you know has -- and oozes the zeal of the newly converted. I plead guilty. With XM Satellite Radio (NASDAQ:XMSR), baby, I've got religion. Whether in the car, at home, or on my PC here at Fool HQ, you'll find me loving my 100 options of music and news, blissfully mostly free of commercials.
I can have whatever I want -- all day Sinatra or music from any of my increasingly numerous decades. All ages, all tastes: from the rawest urban sounds to the sunniest reggae. I can even set my PC to alert me whenever an artist comes up -- anyone for Shelly Berman on a comedy channel?
The need for satellite radio has been obvious for years, ever since a few monoliths led by Clear Channel (NYSE:CCU) captured radio with boring standard formats and ads crowding out the music. Public radio was an alternative but could not be all things to all people. The market screamed for a high-quality product that would spare the decision-impaired (like me) from buying and managing CDs or skulking the world of file sharing -- neither of which delivers BBC World, thank you very much.
The answer
The FCC granted two licenses to visionary U.S. satellite radio providers, XM Satellite Radio and Sirius Satellite Radio (NASDAQ:SIRI). (Privately held Worldspace operates in Latin America, Europe, Africa, and Asia.) The two companies in turn raised the cash (and debt), deployed the system, and launched the service. Huge feats.
Okay, great. They built it. But will they come?
They came
Some months ago I spoke with a friend who frequently visits relatives in rural Pennsylvania. The county's average household income is $30,000, so these are people who must plan their spending carefully. She told me breathlessly that she had never seen anything like it. Everyone she knew there had satellite radio.
The ramping subscriber numbers bear her out. As of June 30, XM had just under 700,000 subscribers, and Sirius, which got a later start, 105,000 -- at $9.99 and $12.99 a month, respectively.
But they didn't come cheap. These businesses are capital intensive and are burning cash, so don't miss the huge red sign here screaming "SPECULATION." Neither company has turned a profit or generates free cash flow, and despite recent financings, a conservative investor would sniff that neither will become self-financing anytime soon.
Rule Breaker investing
Let's turn to the Rule Breaker strategy as a useful way of evaluating high-risk companies in brand new businesses. (In fact, our free online resources start with the Rule Breaking Investment Strategy in Brief, and David Gardner often offers up Rule Breakers in Motley Fool Stock Advisor.) Clearly, both XM and Sirius can identify with the launching point of the strategy:
Quintessential Rule Breaking companies have the potential to change the world. They are brand names, or have brand products that are familiar to virtually everybody. They have true sustainable advantages from brand and visionary management, not necessarily from technological advantage. Since they tend to be young companies, it's important to look through the windshield rather than the rear-view mirror of market history.
Talk about changing the world: We can thank both companies' visionary management for satellite radio's potential to turn traditional radio upside down. Let's see how they stack up against a few more characteristics of a Rule Breaker business:
- First mover and top dog in the industry
- Sustainable competitive advantage
- Strong consumer appeal
First mover
The Rule Breaker concept holds that if you are doing something new and changing the established order, it helps to be the first mover.
eBay (NASDAQ:EBAY) was the first in online auctions. It attracted competition from Yahoo! (NASDAQ:YHOO) and Amazon (NASDAQ:AMZN) and others such as uBid. There was a time when investors seriously debated the odds that one or another serious competitor might dethrone eBay in auctions. Not anymore. EBay had the first-mover advantage and built an insurmountable lead.
The first mover doesn't always win. Sometimes the second player benefits from the first's mistakes, especially when dealing with a complex technology. Sometimes no one wins, as investors in satellite phone providers Iridium and Globalstar learned. But, as a rule, if we are going to take this kind of risk, we prefer to stick with the leader.
(Ironically, Sirius should have been first out of the gate, but chipset problems with Lucent (NYSE:LU) delayed the launch of its national service until July 1, 2002, nine months after XM.)
Nifty products
XM was the first to offer a unit that you transfer from car to home to boombox, as well as a version for PCs. Sirius is just now -- and through the fall -- offering second generation products such as plug and play models, while XM moves ahead to the third generation. Its lower-priced Roady for cars, aimed at Generation Y, arrives in September, and XM's new microantenna is smaller than the new one from Sirius.
Both companies have key deals with major car companies to provide factory and dealer installed options for service -- XM with General Motors (NYSE:GM), Honda, and Toyota, among others, and Sirius with Ford (NYSE:F), DaimlerChrysler (NYSE:DCX), and BMW. But XM wins here too. GM has already manufactured half a million XM-equipped vehicles and projects 1 million by next March; Sirius won't release figures for its partners who are just now getting started.
A Rule Breaker doesn't play catch up. You want to be first, especially in a subscription-based business. Once a customer starts paying for one service, there's major resistance to switching. Millions endure high fees for AOL rather than go through the hassle of changing providers, and you would be amazed at how many people maintain expensive landline telephone calling plans for the very same reason. Add the investment in satellite radio hardware, and you see why first is best.
The closer? XM says its subscriber churn is close to 1%, while Sirius says 1.5%. In satellite radio, once you get 'em, you got 'em.
Top dog
The first mover will usually become top dog, but we want the leader of the pack not only by position, but strength. With 21 months of service for XM and a year for Sirius, we've got some initial numbers to tell us whether first mover XM is kicking sand in Sirius' face.
Interestingly, the market awards Sirius the top spot with a $1.48 market capitalization that's 15% higher than XM's $1.29 billion. But revenues and subscriber growth tell a different story:
REVENUE GROWTH XM SIRIUS Quarter Sequential SequentialEnding Revenues Growth Revenues Growth 06/03 18.3 mil. 40% $2.1 mil. 24% 03/03 13.1 46% 1.6 56% 12/02 9.0 61% 0.7 -- 09/02 5.6 47% 0.0 --06/02 3.8 111% 0.07 --03/02 1.8 260% 0.03 --12/01 0.5 -- 0.0 --
SUBSCRIBER GROWTH
XM SIRIUS Quarter Sequential SequentialEnding Subs. Change Subs. Change 06/03 692,253 43% 105,186 55%03/03 483,075 39% 68,000 127%12/02 347,000 72% 30,00009/02 201,500 48% --06/02 136,500 80% --03/02 76,000 171% --12/01 28,000 --
No question here that XM is the top dog, locking in more subscribers sooner. With 146,000, 136,000 and 209,000 net new subs for the last three quarters, XM is on track to reach its goal of 1.2 million by year-end. Sirius's catch-up product introductions may help it reach its own target of 300,000, but XM wins here.
Other business criteria
Both companies boast visionary management. Ditto, sustainable competitive advantage. After all, there are but two U.S. satellite spectrum licenses, and even if one company fails, the barriers to entry for a replacement would likely be prohibitive. Finally, while satellite radio has strong consumer appeal, XM's higher subscriber numbers suggest it has the lead in brand awareness.
Reward for the risk?
As a Rule Breaker, XM gets the nod -- so far. But there's more. XM's satellite "issue" is a wild card. The Boeing (NYSE:BA) 702 satellite is degrading faster than anticipated at purchase and deployment (though the company says the rate of degradation has remained steady since), and XM has two of them. XM will launch its spare at the end of next year and contract for another. Both companies face the pesky matter of financing. Each improved in the last year, but challenges remain.
Please tune in tomorrow when we'll get, uh, serious about cash burn and all those delightful ingredients in the satellite soup that determine what real chance these companies have to survive and become self-financing. And if they do, what kind of reward may investors expect after their tightrope walk.
Don't miss it. Until then, stay Foolish -- and join the conversations on our XM or Sirius Satellite Radio discussion boards!
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Writer and senior analyst Tom Jacobs (TMF Tom9) welcomes your comments at [email protected] . Find all his Fool.com columns in his archive. Tom owns shares of XM Satellite Radio and others you can find listed inhisprofile. The Motley Fool isinvestors writing for investors.
