Why Is This Man Smiling?
$500 million for Howard Stern, that's why. XM chief Hugh Panero thinks his rival, Sirius, has gone a bit bonkers--which just might leave him with the last laugh.
By John Heilemann

(Business 2.0) – Before my interview with Hugh Panero begins, XM Satellite Radio's CEO informs me that, no matter how relentlessly I pummel him, our session is bound to be a breeze compared with the grilling he's just endured--as a Career Day speaker at his son's elementary school. "It was like talking to a bunch of analysts at an investor conference," Panero quips as we sit in a conference room in XM's headquarters near the Capitol in Washington. "One kid raised his hand and asked, 'So, were you negotiating with Howard Stern too?'"

Since late last year, when XM's archrival, Sirius Satellite Radio, signed the King of All Fart Jokes to a five-year, $500 million contract starting next January, Panero has heard that question ad infinitum--and ad nauseam. (As it happens, the answer is yes, about which more shortly.) He's been badgered, too, about the string of splashy Sirius moves following the Stern deal: the hiring of ex-Viacom chief Mel Karmazin as the company's CEO; the deal with ex-convict Martha Stewart for a lifestyle channel; the victory over XM for rights to future Nascar seasons.

All of which raises the larger question that's ringing in Panero's ears: After four years of XM beating Sirius like a gong, has the momentum suddenly shifted?

His reply is short, blunt, and airily dismissive: "There's a difference between press attention, which is what they have, and momentum, which is what we've got." What Panero doesn't say, but seems evident to me, is that Sirius's flurry of dealmaking--undisciplined, profligate, faintly desperate--may prove its undoing, saddling the company with a crippling cost structure. The question is whether, in bidding up the price of content, Sirius is hanging an albatross around XM's neck as well. And whether, in the end, the best thing for both would be to lay down their arms and join forces.

At 49, Panero, a veteran cable-TV executive, has been running XM since 1998. Back then, XM was the underdog, Sirius the superstar-to-be. But Panero made a pair of decisions that led to a role reversal. Tech-savvy, he decided to develop the chipsets for XM's radios in-house rather than outsourcing the job (as Sirius did). Hip to bundling, he fashioned XM's distribution strategy around automakers such as General Motors instead of big-box retailers (ditto). Though Panero has made his share of mistakes--XM has nearly gone belly-up more than once--these moves were not among them. They helped get XM's service launched faster and better, giving the company a lead over Sirius that it has never relinquished.

XM has 3.8 million subscribers today, compared with 1.5 million for Sirius. But both are growing so quickly that even the laggard proved attractive to Karmazin. Panero says he respects his foe for helping to build terrestrial radio at Infinity Broadcasting. But he clearly considers Karmazin a carpetbagger, and a hypocrite to boot. "He used to tell everyone that satellite radio was a niche business with no future," Panero says. "Now he's a true believer. Whatever."

If nothing else, Karmazin's arrival heralds a new stage in the evolution of satellite radio--a shift Panero understands well. "It's just like in the cable business," Panero says. "You start out focusing on growth, building a subscriber base, as a pure distribution company. Then at some point you have to become a content company--and that's where we are right now, both XM and Sirius."

Thus the competition to land Stern, Stewart, and Nascar. After weighing the pros and cons, XM decided to step away from all three. Panero tells me that Martha was the easiest call: "Her product is mostly visual; we couldn't see how it translated to radio." With Nascar, he points out that XM has broadcast the sport since 2001. That experience gave him a finely honed sense of what the 2007-2011 rights were worth--which, suffice it to say, he thought was a good deal less than the $107.5 million that Sirius wound up paying. (XM paid $15 million for the 2001-2006 rights.)

Then there was Stern. "He's a talented guy with an enormous following," Panero says wistfully. "For $25 million or even $35 million a year, it might have been reasonable. But for $100 million? Half a billion dollars total? It was basically incomprehensible to me."

As it should have been for Sirius. For a company with 2004 revenue of just $67 million, and a net loss of $712 million, to guarantee $80 million a year in cash (the other 20 percent is stock) to one personality teeters on the razor-thin line between imprudence and insanity. And Stern is only part of the picture. Factor in the rest of Sirius's big-ticket contracts--Martha, Nascar, the NBA, the NCAA, the NFL--and you quickly arrive at a figure hovering around $200 million. Annually. Set in stone. And that's with no other megadeals. And it's on top of subscriber acquisition costs, which, thanks to Sirius's reliance to date on retail instead of auto installations, are more than three times XM's.

Gazing on the cash flowing out of Sirius's coffers, Panero can only smile. "There's a certain restraint you need not to be drawn into an Internet-like bubble, where you think everything, no matter what it costs, seems like a good idea," he says. "Sometimes the best deals are the ones that you don't do."

True enough, but Panero himself is hardly a penny-pincher. Last October, XM unveiled a corpulent 11-year, $650 million deal for the rights to Major League Baseball. And the pool of red ink on XM's P&L statement is nearly as deep as the one on Sirius's: a net loss of $642 million last year on revenue of $244 million. Before the MLB deal, Panero had promised positive cash flow in the first half of 2005. Now he's pushed that back a year. "It's only reasonable," he says, "given how circumstances have changed." The worry, however, is that such "reasonable" revisions will keep happening indefinitely.

Both XM and Sirius try to assuage such worries by pointing to the vast and untapped markets stretching out before them: the 229 million vehicles in America, 115 million households, and 125 million people who bought mobile devices last year. The trouble is, both firms are burning cash so fast that the promised land of profitability may prove an ever-receding mirage. "From an investor's point of view, you're either gonna make a lot of money or you're gonna make nothing," Panero says. "The situation is not without anxiety."

Given all this, a merger of XM and Sirius seems obvious and compelling. The two duplicate each other's capital spending, from developing receivers to launching satellites. And they engage in bidding wars for brand-name talent, driving up prices to stratospheric levels. If the companies combined, though, these inefficiencies would disappear. The Federal Communications Commission, for its part, could rest assured that XMSirius wouldn't be a rapacious monopoly. The new outfit would be subject to plenty of competition from terrestrial radio titans such as Clear Channel, which are slowly entering the digital realm with HD radio, as well as from Internet radio.

When I put the idea to him, Panero says, "Satellite radio is going to be a very big business, and I think both companies can be successful." But surely he sees the benefits of a coupling? "I don't devote one instant of my time to thinking about merging," he insists.

If Panero is telling the truth about that, he's less sharp than he seems. So I'll give him the benefit of the doubt and assume he's liberally spreading fertilizer. Two or three years from now, I predict, XM and Sirius will get hitched (unless one of them is snapped up by Clear Channel first). The only question then will be, Panero or Karmazin as CEO? Wall Street will clamor for the latter, but I'll be rooting for Panero. It's always nice to see true believers rewarded not just with cash but with vindication.

Wheeling and Dealing

XM and Sirius are duking it out for space on the dashboard, sports programming, and top radio talent.

Note: XM's Nascar rights run through 2006.