XM Satellite Radio: "What's the Frequency?"

XM Satellite Radio (XMSR-$11.81) said last Thursday that in its 2Q:06 the Company lost $(231.7) million, or $(0.87) per share, as compared to consensus estimates of a share-net loss of $(0.67) on revenue of $227.9 million.

During the second quarter of 2006, the Company added a total of 926,000 gross subscriber additions—the number before subtracting disconnects—slightly lower than the same period last year of 946,000. This number was significantly lower than management had projected, and when reduced by higher-than-expected churn, resulted in a disappointing net subscriber addition number of approximately 400,000.

XM cut its subscriber guidance to a range of 8.2 million to 7.7 million subscribers at year-end 2006, down from previous projections of 8.5 million customers. The Company cited “overall softness” in retail sales of its radio products (XM MP3 radios were delayed and in limited supply at retail for a variety of reasons, mostly product refinement and testing) and FCC regulatory issues over permissible emission limits of its ‘plug-and-play’ radios.

In the second quarter 2006, ARPU (average revenue per user) was $10.08, flat compared to the first quarter. XM SAC (subscriber acquisition costs) for the second quarter of 2006 was $64 compared to $62 in the first quarter of 2006. However, the broader measure of cost per gross addition, or CPGA, which includes SAC and discretionary advertising and marketing costs, was $112 in the 2Q:06, compared to the $94 in the first quarter of 2006. CPGA was higher than expected due to lower growth subscriber additions, as well as $4 (per user) for FCC expenses.

Putting a positive spin on the dismal quarter, Joseph J. Euteneuer - Executive Vice President and Chief Financial Officer, said on the Company’s 2Q conference call: “we continue to acquire subscribers on a cost-effective basis. Our SAC, while elevated over the first quarter, remains low and leads the industry by a wide margin.” [Ed. note. Hello? Are we on the same frequency? Simple math—CPGA greater than ARPU does not = profits!]

Messer. Euteneuer then unctuously said: “Our adjusted pre-marketing EBITDA, excluding stock-based compensation, was $60 million in the second quarter of 2006, compared to $50 million in the first quarter of 2006 and $10 million in the second quarter of 2005.

The improving trend is a strong indicator of the longer-term ability of our business to generate substantial cash. Pre-marketing EBITDA captures the positive trends in subscription revenue, improving margins and fixed cost leverage….”

[Ed. note. Again—what’s the frequency, Joseph? The Company just closed on a refinancing on May 1st of an $800 million debt offering, consisting of new, unsecured floating- and fixed-rate bonds (due 2013 and 2014, respectively)—which the 10Q Detective discovered—after reading the Registration Statement (Form S-4)—that XM is not yet generating sufficient cash flow from operations to meet the interest due obligations on the notes (cash interest payments on the notes began on August 1, 2006).

Operating Expenses (such as revenue sharing and royalty agreements, customer care and billing, and programming & content) and Marketing Expenses (including advertising & marketing and distribution) ate up approximately $1.08 of every dollar in sales in the 2Q:06. What cash flow?

Of interest to the 10Q Detective, too, was that despite the presence of (presumably intelligent) analysts—the likes of Bear, Stearns & Co., CIBC World Markets, and JPMorgan Chase & Co.—the management of XM fielded nothing more than fluff questions during the Q&A session of the conference call.]

Resetting marketplace expectations lower, the continued need for operational financing (cash flow problems), and lingering investor concerns on actual demand for XM’s portfolio of services (Sirius captured market share from XM in the retail segments in the latter stage of the second quarter)—nevertheless, the Common Stock of XM gained $1.80 in the past week, closing 17.4% higher at $12.16 on August 2, 2006. Average daily trading volume jumped to approximately 16.7 million, double the average daily trading volume in the prior three months.

On Wednesday, August 2, 2006, XM and online search engine Google (GOOG-$375.39) announced an airwaves advertising pact. Terms were not disclosed, but as part of the agreement Google’s AdWord’s customers will be able to insert advertising across XM’s non-music commercial channels (i.e. talk-based shows).

The arrangement will help Google to increase ad-enabled sales across a new audience platform for its advertisers.

What’s in the deal for XM? Short-term, not much (save for getting investors excited about the fact that Google has now lent some well-needed credibility to XM’s satellite-radio business)—longer-term, it just might open-up a new revenue stream (by allowing XM to feature new advertisers while lowering the costs related to processing ads). Net ad sales revenue totaled $8.9 million, or approximately 4.0%, of the $227.9 million in net sales in the second quarter of 2006.

The 10Q Detective understands that the S.E.C. is involved in (higher-profile) backdated option scandals, but does the pre-announcement spike in the price and volume in XM’s Common Stock strike any of our readers as too timely?

• "What's the frequency, Kenneth?" is your Benzedrine, uh-huh
• I was brain-dead, locked out, numb, not up to speed
• I thought I'd pegged you an idiot's dream
• Tunnel vision from the outsider's screen
• I never understood the frequency, uh-huh
• You wore our expectations like an armored suit, uh-huh….”
  

“What's the Frequency, Kenneth?" is a song by the rock group REM from their 1994 album Monster. The title refers to the question one of two unknown assailants asked CBS anchorman Dan Rather as he assaulted him on Park Avenue in Manhattan in October 1986.

R.E.M. vocalist Michael Stipe said of the incident: "It remains the premier unsolved American surrealist act of the 20th century. It's a misunderstanding that was scarily random, media hyped and just plain bizarre."

The Common Stock of XM Satellite Radio gaining almost 17% on lackluster news—come on, S.E.C.—“What’s the frequency?”