Sirius Pain

XM and Sirius could both lose the satellite radio wars.

Satellite radio companies Sirius and XM Satellite Radio have been two of the big disappointments in a very solid year for the markets. As this chart shows, both are down by nearly half so far this year.

To a degree, this result was highly unexpected. Both Sirius and XM seemed to have pulled off successful hybrids, merging a well-established old medium (radio) with a technology-based new distribution system (satellite) to create an entirely new medium: advertising-free radio offering vast choices. Nationwide National Public Radio, yes, but also good music, sports, and raunchy talk.

Because they were able to raise vast sums of cash, the two companies were able to spend heavily to attract blue-chip talent. In the fall of 2004, Sirius recruited Howard Stern, as well as Stern’s former boss, ex-Viacom CEO Mel Karmazin. XM has Bob Dylan and Tom Petty, Opie & Anthony, Major League Baseball, NASCAR, and Oprah & Friends. Sirius has Stern, NFL football, the NCAA Basketball Final Four, and Cardinal Egan of New York. They also struck deals with car companies, which would offer satellite radio as a pre-installed option.

But while subscribers have followed the talent and the programming, profits haven’t. And to a large degree, these new companies are re-enacting a drama seen time and again in American business history. Pioneers rarely have the commercial space to themselves for very long. Satellite radio was a great idea when it got started in the late 1980s and early ‘90s. And in the United States, a great idea gets funded—and funded big-time—more than once. As a result, bidding wars erupt for suddenly scarce commodities—executives, talent, programming. In the absence of XM, Sirius wouldn’t have been forced to pay so much for Karmazin, Stern, and college basketball. In the absence of Sirius, XM wouldn’t have been forced to pay so much for Oprah and NASCAR.

Next, a zero-sum mindset emerges in which each competitor regards a single subscriber to the other as a lost sale. And so, in addition to spending lots of money on talent, the young companies spend lots of money on marketing—or slash prices and offer rebates. And thanks to competition, companies lose the ability to name their own price. An XM subscription costs $142.45 for 12 months. Sirius is also $142.45 if you subscribe for a whole year. Meanwhile, after years of very high sales, artificially inflated by zero-percent financings and huge incentives, some of the big automakers are cutting back production.

And so, instead of a huge expansion, the two competitors are in the midst of a pinched expansion. While the number of subscribers is growing, it’s growing far more slowly than they expected at the beginning of this year. And they’re being forced to spend more to acquire those customers. That combination is stock market poison.

In January, XM said its subscriber rolls would rise 50 percent in 2006, from 6 million to 9 million. In the first quarter, it added 568,902 net subscribers, while its subscriber-acquisition cost rose to $62 per head, from $52 in the same quarter of the previous year. During the second quarter, in which it added just 398,000 net subscribers, XM cut back its year-end forecast to 8.5 million. In the third quarter, XM added 868,007 new subscribers, but because of significant churn—i.e., cancellations and lost customers—it added only 286,002 net customers, about half the first-quarter total.

In January, Sirius said it closed the year with 3.32 million subscribers, having added 1.14 million in the fourth quarter of 2005 thanks to the impending debut of Howard Stern on Jan. 9, 2006. But things have slowed down since then. In the first quarter, Sirius attracted 761,187 net subscribers. In the second quarter, Sirius added 600,460 net subscribers. In the third quarter, the total came to 441,101, and the average monthly churn was 2 percent. On Dec. 4, Sirius provided updated guidance, saying that instead of finishing the year with 6.3 million customers, as it had projected back in August, Sirius would close 2006 with between 5.9 million and 6.1 million subscribers.

As much as they have pulled in their horns, Sirius and XM still don’t sound particularly realistic. Both are expecting monster fourth quarters. XM expects to add between 515,000 and 715,000 net subscribers in the quarter, while Sirius expects between 681,000 and 981,000. That’s huge, especially given the falloff throughout the year and the churn rate, which causes Sirius to lose about 100,000 customers per month

Even if they both come up short this year, Sirius and XM will have built an impressive market.But the growth is coming at the expense of profits. And even well-funded firms have limited life spans.At the end of the third quarter, in which it lost $154 million on operations, Sirius had $352 million in cash and $1 billion in debt. At the end of the third quarter, in which it lost $60 million on operations, XM had $285 million in cash.

The business models of expensive talent, discounted subscriptions, and heavy marketing clearly aren’t sustainable for too much longer. And so it’s not surprising that analysts have begun to speculate about a potential merger. A merger of equals is certainly possible, though not likely given the egos involved. More likely is a situation in which one falters significantly and the other pounces for an acquisition. A third possibility, which analysts seem unable to contemplate, is that both could fail, and somebody else could end up with both of their carcasses.

For XM and Sirius, the main challenge is probably cultural as much as it is financial. The half-life of a great idea is exceedingly short in the 21st century. In a world where radio mediocrities—the generic KISS-FMs and HOT 97s—dominated Americans’ ears, the concept of paying for an advertising-free set of music channels made lots of sense. But in a world where the Internet and the iPod allow people to assemble, carry, and play vast multimedia libraries with them wherever they like, not so much.