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Satellite radio ga-ga
Sirius and XM are adding subscribers at a nice clip but their stocks are in the stratosphere.
February 3, 2004: 1:48 PM EST
By Paul R. La Monica, CNN/Money senior writer

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NEW YORK (CNN/Money) - Satellite radio is a great service but shares of Sirius Satellite Radio and its larger rival XM Satellite Radio continue to orbit (couldn't resist) in some pretty rarified air.

So even though both stocks have slipped about 11 percent so far this year, investors need to be wary. Sirius and XM were among the biggest gainers of 2003: Shares of Sirius (SIRI: Research, Estimates) surged nearly 400 percent while XM (XMSR: Research, Estimates) skyrocketed almost 900 percent.

The allure of satellite radio is fairly simple. They offer much more variety than the mediocre, cookie-cutter pop that's manufactured by the major record labels and spoon-fed to listeners by the oligopoly of big radio station owners. Both companies' music stations are commercial-free as well.

This makes satellite radio particularly appealing to people who listen while they drive. As such, Sirius and XM derive the bulk of their subscribers from having their radios pre-installed by automotive giants. DaimlerChrysler and Ford have licensing agreements with Sirius while General Motors and Honda are aligned with XM.

Sirius and XM reported healthy levels of subscriber growth last year and are expected to do so this year as well. As of year-end, Sirius had about 261,000 subscribers (up from only 30,000 in 2002) and XM had about 1.3 million subscribers, compared to about 350,000 in 2002.

However, revenues are still fairly small for both companies and profits are not likely until 2006 or 2007 since the companies had huge start-up costs (i.e. launching the satellites).

So the main thing that moves these stocks are reports and speculation about subscriber growth. That makes them extremely volatile. "The joke is that these stocks trade at 10 times news flow," said Ethan McAfee, an analyst with Capital Crossover Partners, a hedge fund that has no position in either stock.

With that in mind, Tom Watts, an analyst with SG Cowen, thinks that the stocks will probably continue to pullback over the next few months because he sees no major news events on the horizon until August when the automotive companies start to roll out plans for their 2005 models. So at that point, analysts should have a better indication of what subscriber growth could be like next year.

"Between now and August, the satellite radio companies are in a lull period. I don't see upside surprises that will move the stocks," Watts said. "There's nothing wrong with holding the stocks for the long term but investors should be able to buy them cheaper in the next few months," Watts said.

Multiples are sky-high

In addition, these stocks are just way too pricey. Even if you believe that both companies should survive and eventually become profitable (which I do), it's hard to justify the current valuations.

XM Satellite trades at 14 times 2004 sales estimates and Sirius trades at about 40 times 2004 revenue projections. By way of comparison, satellite TV company EchoStar (DISH: Research, Estimates) trades at 2.7 times estimated revenues for 2004.

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Sure, the radio companies are younger and have higher growth prospects so you'd expect some sort of premium. And April Horace, an analyst with Janco Partners, said the satellite radio companies, like EchoStar, are appealing because they generate a predictable stream of revenues.

But consider this. XM charges about $9.95 per month for its service while Sirius charges $12.95 a month. EchoStar's most basic TV package is $29.95 per month. But thanks to premium services, the company's monthly average revenue per user (ARPU) in its most recent quarter was nearly $51.

Sirius, however, reported last week that its ARPU in the fourth quarter was just $8.95 due to the impact of mail-in rebates. XM, which will report its fourth quarter results, next week, reported ARPU of only about $9 in the third quarter.

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XM Satellite Radio Holdings Incorporated
Sirius Satellite Radio Incorporated
By Paul R. La Monica

Unless the radio companies are able to launch a wide array of services, it's highly unlikely they will ever be able to get as much money out of its subscriber base as EchoStar. That makes the premium that the radio companies trade at way too high.

Hoarce, who likes both stocks, concedes that satellite radio stocks are not for the faint of heart. "It takes a certain technology investor to understand the kind of risks they are buying," she said.

And Watts said that because satellite radio is still in its infancy, the stocks should remain a "trader's delight" for the foreseeable future.

In other words, the average investor should probably sit back and wait for these stocks to come back to earth before making any big bets.

Analysts quoted in this story do not have positions in Sirius or XM. Janco Partners has done investment banking for XM. SG Cowen has no investment banking relationships with either company.

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