Lessons From the Sirius XM Story

Featuring Lutts’ Logic:

The Sirius XM Story

Too Much Spending

Femtocells, Again

Today I start with a review of the high points of the XM Radio/Sirius Radio saga, which has important lessons for all of us.

The roots of Sirius Satellite Radio date to 1990, when ex-NASA engineer Robert Briskman formed a company called Satellite CD Radio in Washington, D.C.

Two years later, American Mobile Satellite Corporation established a unit called American Mobile Radio Corporation dedicated to developing a radio service broadcast from satellites. 

By 1994, Satellite CD Radio had spent $10 million on development costs, while accumulating a deficit of $9.5 million. That year, the firm made an initial public offering of stock on the NASDAQ, raising close to $7.5 million.

In April 1997, after a fierce legal battle against the anti-satellite radio establishment, Sirius bought the first of two licenses granted by the FCC to broadcast digital radio signals, paying $83.3 million at auction.

The other license was bought by American Mobile Radio, and thus was born a legal duopoly, which I, for one, thought would be a terrific structure for making money.  But it didn’t work out that way.

Five years later, American Mobile Radio was spun off as XM Satellite Radio in the bull market of 1999; it began trading at 13 in October 1999.

Also in 1999, American Mobile Radio filed suit against its rival for patent infringement … not a smart way to spend money, particularly since, at this point, neither company had a service, or customers, let alone revenue and profits.

In November of that year, American Mobile was renamed Sirius Satellite Radio, and it moved into a new $38 million, 100,000-square-foot space in Manhattan.

XM Satellite Radio, meanwhile moved into its own well-equipped quarters outside Washington, D.C.

In February 2000, Sirius and XM ended their legal standoff and agreed to jointly develop unified standards for satellite radio.

By July 2000, Sirius had launched one satellite, while XM had launched none; Sirius was ahead … but it was still providing no service.

XM got its satellites into orbit in 2001, and began signing up subscribers; now Sirius was scrambling to catch up.

Finally, in July 2002, Sirius launched its nationwide service.

At the end of 2003, XM had 1.36 million subscribers, while Sirius had only 261,000

So in October 2004, fueled by competitive juices, Sirius signed Howard Stern to a deal worth an astounding $100 million per year for five years.

The winner:  Howard Stern … and his listeners.

The losers: All the Sirius shareholders, who saw the opportunity for the company to make a profit pushed even further into the future.

Admittedly, XM never made a profit either, even without the bank-busting paycheck of Howard Stern.

After the costs of developing satellites, the costs of developing programming, and the costs of paying big bucks for stars, there were no profits for either company …. and to this day there have been no profits made in the business.

Hemorrhaging money, the companies begged the government for permission to combine (even though when the duopoly was instituted, merging was strictly forbidden), and on March 24, 2008, the United States Justice Department approved the merger of Sirius and XM (after the longest approval process in United States history) and the Federal Communications Commission followed suit on July 25, 2008.

On July 29, 2008, XM and Sirius merged.

And in the year since then they’ve reduced redundancies and found the path to profitability, right?  Wrong!

In the latest quarter, ended September 30, Sirius XM saw record revenues of $619 million, and it lost a penny a share.  Analysts now estimate that in 2010, the company will come very close to breaking even.

But here’s the problem.  For years, subscriber growth came mainly from sales of new cars … and that’s a business that’s now in the toilet.  Sirius ended this quarter with 18.5 million subscribers, down from 18.9 million a year ago.

And the company remains deep in debt.

Sirius stock (SIRI), by the way, is now trading at about sixty cents.

Ironically, when there no customers and no revenues, back in 1999, the companies were valued at more than $260 billion.  Now, with more than 18 million customers, the market says Sirius XM is worth just $2 billion!

So was there ever a way to invest profitably in these companies.  YES!

The first phase would have been in the period prior to the big market top of 2000.  At that point, when neither company had subscribers, the stocks were climbing on hopes and dreams, on the perception that someday these two companies could make big bucks from their government-sponsored duopoly.  I was a big fan back then, but because the companies had no revenues, we didn’t advise investing. 

After 2000, both stocks went south for years.

The second time to make money was after the 2002 market bottom, when both companies were selling subscriptions, and the stocks were rebounding strongly.  In fact, Cabot Market Letter subscribers made 644% on XM Satellite Radio by holding from March 2003 to May 2004!

But the trend didn’t last, as the weight of debt brought the stocks tumbling down.

The third time to make money was earlier this year, as SIRI rebounded from five cents to 70 cents.  A nice profit, if you could snag it, but the risks are high in those low-priced waters.  We don’t play with penny stocks, period.

So what’s the lesson?  Often, the sizzle is better than the steak.  Romance is better than reality.  And finally, you can’t predict the future.  When investors were high on the prospects of XM and Sirius, they didn’t foresee the massive spending that would put each company deep in debt, they didn’t foresee the dominance of the iPod, and they didn’t foresee the collapse of the automobile industry.

Yet you could have made very good profits from the stocks, simply by watching the stocks and investing when the uptrends were in effect.

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And now today’s investment idea.

Back on October 19, I wrote the following:

I’ve got an iPhone.  In fact, my wife and two of my three kids have iPhones.  The iPhone is absolutely wonderful as a portable computer, camera, music player and casual gaming device.  I use it to check on stocks, keep notes, view maps, find where I am, figure currency conversions, send instant messages, play Scrabble and more.  But the iPhone is a disappointment as a phone . . . and the problem is getting worse, because every new iPhone user (Apple sells roughly 80,000 iPhones a day) puts greater demands on AT&T’s network.

The problem may ease a little when AT&T gets its LTE (4G) network deployed in the years ahead.  And it may ease a little more in 2011, when Verizon starts carrying iPhone traffic.

But I can’t wait, which is why at the top of my Christmas wish list it says, “One femtocell.”

What’s a femtocell?

In short, it’s an in-home cellular tower that covers up to 5,000 square feet, and that connects to your cable or DSL connection, so that your cell phone activity (voice and data) travels on the Internet and not on those crowded airwaves.

It’s not really a tower.  It’s really just another plastic box.

Sprint and Verizon are already marketing similar devices, under the names Airave and Network Extender, but they only work with 2G handsets, and only for voice calls.

The device AT&T is just beginning to sell, however, is designed specifically for 3G smartphones, so it carries both voice and data.  2G phones can’t use it.  Dubbed Microcell, it’s branded with a Cisco logo, but in fact the innards are probably from ip.access, a non-public company Cisco invested in last year.  When you set it up, you can authorize up to 10 phones to use it (so your neighbors can’t piggyback on the signal), and up to four of those authorized phones can use it at any one time.  Voice quality is crystal clear.  And if you leave the femtocell’s range in the middle of a call, it hands off seamlessly to the regular cellular network. There’s more information on the AT&T Web site.

But I can’t buy one yet.  AT&T began selling the Microcell less than a month ago in select markets: Atlanta, San Antonio, Seattle and North Carolina.  There’s no word on when it will come to the Boston area, but I’m keeping an eye out.

And I’m betting that when word gets out, demand will be terrific … especially as the AT&T network gets worse with every new iPhone sold.

Plus, I’m not the only one.  Over at http://www.thinkfemtocell.com, David Chambers says, “The state of the femtocell market today can be compared to a scene in an action movie, where the large dam has been blown up, the audience is holding its breath waiting for the enormous wall of water to descend, but only a trickle is so far seen to appear.”

Another researcher predicts that femtocells will be a $12 billion market by 2012.

So what’s my stock recommendation?  It’s not AT&T (T) and it’s not Cisco (CSCO).  They’re big old slow-growing companies.  Their best days as investments ended long ago.

And it’s not Apple (AAPL), though there’s nothing wrong with that idea.  One look at the charts of competitors Research in Motion (RIMM) and Nokia (NOK) tells you those guys are hurting while Apple is smelling like a rose.

My recommendation is an attempted home-run swing with an unknown little player in the femtocell market, a company whose revenues were just $4.9 million in the second quarter … mainly from non-femtocell electronics.

The company, located here in Massachusetts, has been working with Alcatel-Lucent, Motorola, Hitachi, Nokia Siemens, Thompson Electronics and Pirelli … and most of all, Nortel.  But Nortel filed for bankruptcy back in January, which not only slowed business down but also made the stock pretty cheap.  Since then, Nortel’s relevant intellectual assets have been acquired by Ericsson (for $1.13 billion), and I have little doubt that Ericsson will be a big player in the femtocell market using this company’s technology.

In the meantime, the company has been recently buying its stock back, a clear indication of how cheap management thinks it is.  (It’s currently trading around 7.)  Another fan of the stock is Tom Garrity, editor of Cabot Small-Cap Confidential, who recommended the stock back in July, when it was trading at 6. 

Here’s a little of what he wrote:

“The average operator’s core traffic, measured in terabytes, is up some 35 times in the past year. Data is flooding the network and carriers are struggling to stay afloat. [Company X] is here to teach them how to swim.

“[Company X’s] established relationships with the biggest players in the telecom industry have us imagining a day when its superior technology is not only dominant, but ubiquitous. In other words, we think this company is setting a new industry standard. [Company X’s] wireless technologies and its network management software are second to none. Investors have an opportunity here to get in at the beginning of a period of industry-transforming growth of a kind that’s not seen every day.”

Now, back in October, when I first wrote about it here, I couldn’t tell you this little company’s name because it just wouldn’t be fair to paying subscribers of Cabot Small-Cap Confidential.

Buy today I can.  It’s Airvana (AIRV), and the reason I can tell you today is that last Friday a group of private equity investors (combined with current management) announced they’d buy Airvana for $530 million, a premium of 23% over Thursday’s closing price.  So the stock zipped up 23% on Friday, and it pulled back a little today.

But here’s the interesting part of the story.  Numerous legal firms jumped into the fray immediately.  They’re fishing for shareholders to get on board class action suits that claim the buyout price is too low.  And editor Tom Garrity agrees; he told his subscribers today to sit tight.  He suggests another suitor might emerge and a bidding war might erupt to drive the stock higher.  Time will tell.

All I know is that the femtocell story continues to be one of my favorite technology themes.  With data-hungry smartphones proliferating around the world, demand is growing for technology like Airvana’s that gets traffic off the airwaves and onto wires.

So if you’re one of the smart, resourceful readers who figured out the identity of Airvana when I wrote about it in October and bought some, congratulations.  I suggest you sit tight.

But if you’re part of the vast majority who are just learning about this technology with the POTENTIAL to solve the smartphone traffic problem, I have two suggestions.

The first is to buy a little AIRV now.  The odds are still good that it will inch higher.

The second is to give yourself a present.  Take a subscription to Cabot Small Cap-Confidential, and be among the first to receive editor Tom Garrity’s next investment recommendation.  Join an exciting world full of unknown little companies with great growth potential.  Click the link below to learn more.


Yours in pursuit of wisdom and wealth,

Timothy Lutts
Cabot Wealth Advisory


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