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Mixed Signals from XM and Sirius

By Amy Tsao Most startups would die for the word of mouth that satellite radio has generated since it hit the airwaves a few years ago. Small wonder. Traditional radio may be free, but it's often canned or computer-generated, and crammed with advertisements. Instead, for a small monthly fee, satellite radio's listeners get access to dozens of stations that cater to very sophisticated musical, news, sports, and talk-show tastes, with no ads. Roughly 60% of consumers who buy cars equipped with satellite radio sign up for the service. By the end of 2004, some 4 million-plus in the U.S. are expected to subscribe.

That bodes well for the two big players, XM Satellite Radio (XMSR) and Sirius (SIRI). There will be some 19 million subscribers by decade's end, predicts April Horace, analyst at Janco Partners, a Denver-based investment banking firm. By then, both outfits, which are still losing vast sums of money, should be quite boldly into the black, Horace thinks. (Horace does not own shares and her firm does not have banking relationships with either.)

FAST LANE. Five years is a long ways off, however. So which player looks better poised for growth? Each offers very similar products. XM charges $9.95 monthly, Sirius $12.95. Yet, XM is well ahead of Sirius, having introduced its service about one year earlier. As of the second quarter, which ended June 30, XM boasted 2.1 million subscribers, vs. 480,000 for Sirius.

Financial performance at XM, too, has been better than Sirius, so it is expected to turn the corner on profits sooner. XM predicts it will break even by mid 2005. Its carmaker partners, General Motors (GM) and Honda, have said they will outfit more than 1.5 million of their 2005-model vehicles with XM radios. XM spokesman Chance Patterson says this means the goal of 3.1 million subscribers by yearend is attainable.

XM's cost of doing business is also coming down -- quickly. In 2004's second quarter, it cost the outfit $101 to acquire each new subscriber, down from $160 in the same period a year ago. And that figure should drop below $100 before yearend, says Banc of America analyst Jonathan Jacoby. In it second quarter, XM reported $166 million in net losses, on $52.9 million in revenues. (Banc of America has received fees from both companies in the past.)

"MAKE OR BREAK." Relationships with car companies are key to gaining ground in this market. "That's the big difference between XM and Sirius," says David Kestenbaum, analyst at New York City-based Independent Research Group. XM's deals with GM and Honda came sooner -- and with more marketing push from the automakers themselves. Sirius' partners, DaimlerChrysler (DCX) and Ford (F) are arguably the weakest in the auto industry. And so far, neither has made satellite radio a priority, as XM's partners have done. (The analyst does not own either stock, and the firm has no investment banking business.)

In the coming quarters, Sirius is probably in the tougher spot. Analysts say it must show success in its new efforts to add subscribers -- including programming deals with the National Football League and distribution through electronics retailer Radioshack (RSH) -- or run the risk of XM taking an even bigger lead. "They're not out of the game," says Jacoby, "but being second makes it harder for them."

Subscriber-acquisition costs also remain relatively high at Sirius -- $234 in the second quarter, more than double XM's. While Sirius has promised that the figure will drop, -- to an average of around $200 per subscriber for the full year -- analyst Kestenbaum has his doubts. "That doesn't seem possible," he says. In its second quarter, Sirius reported $136.8 million in losses on $13.2 million in revenues. Some question the outfit's ability to attract the critical mass of subscribers it needs to breakeven. "I can't say they have been executing that well," says Kestenbaum, who thinks "the next two quarters are make or break." He rates both stocks neutral.

WARMER RECEPTION? For its part, Sirius says its carmaker relationships are getting stronger. And as they do, "lots of things about our business will look more like XM," promises chief financial officer David Frear, who says that its agreement with Daimler Chrysler will see Sirius radios in over 500,000 units, or roughly 12% of the automakers' total production, between June 2004 and June 2006. Frear also assures that Sirius can meet its target of a total of 1 million subscriptions by year's end, and he is optimistic that next year's acquisition costs will fall below 2004 levels.

A nagging issue for some investors is Sirius' stock dilution. There are more than 1 billion Sirius shares outstanding. Though the stock price looks cheap at $2.40, as of the closing bell on Aug. 25, it strikes Susan Fulton, principal at WealthTrust FBB, as trading at a higher valuation than XM, which closed at $27.60. "I like both companies, but XM has kept more shareholder value alive," says Fulton. (Her firm owns XM stock and she personally owns shares in XM.)

Since the rise of satellite radio is still in the very early stages, it may be of little consequence who is winning now. "I don't think we need to catch XM," says Frear, noting that some 16 million new cars are made each year. That could be, but investing in leader XM could be the more solid bet. Tsao reports for BusinessWeek Online in New York

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