This Is the Dawning of the Age of--XM?

The satellite radio service is picking up subscribers fast -- but competition and cash burn are big worries

Gary M. Parsons was planning to spend September 11, 2001, preparing for the debut of XM Satellite Radio's new service. The chairman was scheduled to host a launch party on Sept. 12 at the Washington company's state-of-the-art studios with celebrities like Quincy Jones and Ziggy Marley. But on his drive to work that Tuesday, as he crossed the Potomac River on the 14th Street Bridge, Parsons saw a fireball explode at the Pentagon. Just like that, XM's grand affair seemed inconsequential. He pulled the plug on the party and canceled an ad campaign featuring Snoop Dogg falling down the side of a skyscraper. "Very little that day was going through my mind about XM," says Parsons.

Despite the rough start, XM is beginning to take off. Since launching without fanfare on Sept. 25, 2001, the company's crystal-clear, digital radio service delivered via satellite for $9.99 a month has started to catch on. Some 600,000 subscribers have signed up so far, and Parsons expects 1.2 million by yearend. The attraction? Customers can choose among 101 different stations, offering everything from classical to alternative rock, from BBC news to ESPN sports coverage. And because XM is delivered from satellites that cover the entire continental U.S., stations never fade out when listeners are driving, like traditional AM and FM stations do. "I don't think I can be without XM now," says Brad Johnson, a 36-year-old technical systems manager at Pepperdine University who listens during his hourlong morning commute.

Will others catch the rhythm? XM's primary competition is traditional AM and FM radio, which may not have the breadth and coverage of the satellite service, but has the distinct advantages of being free and available on standard car and stereo equipment. XM requires that customers pay $200 or so up front for equipment along with its monthly subscription fee. It also has a rival in New York's Sirius Satellite Radio Inc. Sirius, which costs $12.95 a month for 100 stations, is completely commercial-free, while XM has a small amount of advertising. Sirius has signed up 100,000 subscribers.

Perhaps the biggest worry is XM's own pocketbook. Even after restructuring its debt last year, the company is expected to lose $562 million this year on revenues of $85 million. It's burning through an estimated $20 million in cash a month and has just shy of $400 million in the bank. Some analysts think XM will hit 2.5 million subscribers and begin to generate cash from operations by the end of 2004. Slower subscriber growth, however, could prove troublesome. "It will be close," says analyst April Horace of investment bank Janco Partners Inc., who thinks XM has enough cash. "If they don't make subscriber gains, the business plan is at risk."

Real profits will take a bit longer. To cover its capital and interest costs, XM needs to reach 7.5 million subscribers and about $1 billion in revenues. Deutsche Bank Securities (DB ) Inc. expects the company will hit those figures in 2008.

To reach those targets, XM will get a little help from its friends. General Motors Corp., which invested $100 million in XM in 1999, plans to make satellite radio available in almost all of its cars. By the end of this year, 44 of GM's 57 car lines will come equipped with XM up from 25 last year. Toyota and Honda (HMC ) also are signing on. That's not all. Customers can sign up for XM radio in their homes if they pick up specially equipped boom boxes available through major retailers like Best Buy, Circuit City, and Wal-Mart Stores. For his part, Parsons has no doubt XM's satellite radio will attract legions. "It will change the way people listen to music, news, and information," he says. "Once you've heard it, you can't be without it."

Parsons brings years of experience to the venture. The middle child of a homemaker and an exec of a fishing rod company, Parsons, 53, grew up in Columbia, S.C. After graduating with an engineering degree from Clemson University and an MBA from the University of South Carolina, Parsons worked 10 years for BellSouth (BLS ) Corp. He caught the entrepreneurial bug after his wife, Kathy, started her own ad agency. "She proved to me you could do it and not starve," he says. After Ma Bell's breakup in 1984, Parsons joined long-distance startup Telecom*USA, went to MCI Communications in 1991, and six years later, became CEO of American Mobile Satellite, a data-services company that was experimenting with satellite radio. He decided to push the project, and XM was born.

Even as a boy, Parsons demonstrated a passion for radio. While in high school, he worked as a disk jockey playing contemporary music nightly on "Gary Parson's Night Flight" at WKDK-AM in small-town Newberry, S.C. But that job cost him. After he was elected student-body president, school officials ousted him from the president's post because they didn't want a deejay representing the school. "Gary made a big stir," recalls older brother Jim, a construction company manager. "Radio tends to get in your blood," explains Gary.

That passion helped fuel Parsons through XM's touch-and-go moments. The most dramatic occurred last year when XM was running out of cash and its survival was at stake. Last fall, GM agreed in principle to stretch out the payments it was owed by XM, but the auto maker wouldn't defer collection unless XM could get fresh money from private investors. George Haywood of New York and Rick Barry, managing director at hedge fund Eastbourne Capital Management LLC, were interested, but they wanted a commitment from GM first. By October, the two sides were at a stalemate.

Parsons almost scared up cash elsewhere. NBC considered investing a significant amount but backed out in early December after it decided "it wasn't the right time," according to NBC Executive Vice-President Brandon Burgess. The New York Times (NYT ) Co. was going to kick in $25 million, but dropped out after defects forced XM to accelerate the launch of a spare satellite, according to Eastbourne partner Eric Sippel. New York Times officials declined to comment.

With cash running out, Parsons went back to GM. Since the last round of talks, GM had more time to study the sales of XM-enabled Cadillacs. The numbers were so impressive that GM executives were convinced XM's potential was enormous. Once GM committed, other investors quickly followed. At 5 a.m. on Dec. 23, GM led a group of investors in a $450 million refinancing for XM. GM deferred until 2006 $250 million in payments that XM owed it for loans, bonds, and revenue-sharing plans. A group that included Haywood, Barry, Honda Motor Co., and Hearst Corp. put in $200 million in new cash. In return, XM agreed to develop data services, such as weather and traffic, for Honda cars.

XM's success rests on more than just financial engineering. Parsons and his partner, CEO Hugh Panero, made several smart moves that helped it pull away from rival Sirius. The most important one came five years ago. XM decided to develop its radio chipset in-house, while Sirius outsourced its chip design to what is now Agere Systems (AGR ) Inc. Sirius' chips were delayed, which gave XM a year's headstart in the market, says Horace of Janco Partners. An Agere spokeswoman says it's common for complex chips to go through several revisions.

Last year, XM also decided to design a new line of radios in-house. Sold at retail stores, the easy-to-install radios have lowered XM's cost of subscriber acquisition to $74 in the first quarter, compared with $125 at the end of last year. XM pays only $35 to subsidize each of these radios, compared with $130 for its original radios.

There are still plenty of challenges ahead. XM must achieve its subscriber target. It faces plenty of competition from other technologies, such as the Internet, where downloading music is popular and often free. But XM is betting that young users will be just as excited by the prospect of mining XM's vast selection of new and unexpected music. And the quality of XM's sound is generally superior to anything that can be downloaded from the Web, let alone captured on AM or FM radio. "XM is a different definition of what we've heard all our lives," says Quincy Jones, who advises the company on its programming.

XM has defied the odds so far. That's why many analysts and investors believe the company can achieve its goals, signing up nearly 10 million users by the end of the decade. If it can do that, it may yet have a shot at the stratosphere.

Corrections and Clarifications "This is the dawning of the Age of--XM?" (Information Technology, July 7) stated that Sirius Satellite Radio Inc. is "completely commercial-free." While this is true for the broadcaster's 60 music channels, most of its 40-plus talk channels do carry ads.

By Catherine Yang in Washington, with Diane Brady, Adam Aston, and Steve Rosenbush in New York

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