Satellite in Trouble as HD Grows

As the hot summer months course through the 2006 calendar, we are beginning to see a number of important evolving events and clues emerge that preview how the competing forces of satellite radio and HD are likely to fare in the future.
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As the hot summer months course through the 2006 calendar, we are beginning to see a number of important evolving events and clues emerge that preview how the competing forces of satellite radio and HD are likely to fare in the future.

Satellite radio recently has passed the 11 million mark in total subscribers, and may announce more around the time this issue reaches you, as both XM and Sirius continue to spin their growth stories moving towards profitability "in the near future." Not much has altered the business plans that the companies have fashioned to gain a foothold in the radio landscape: increase content offerings with big brand names in the lineup to attract and sign up enough subscribers to pay expenses and, eventually, make a profit.

But some of these additions, like Major League Baseball, the NHL, the NBA, NASCAR, Howard Stern, Martha Stewart and Oprah, have been obtained at ridiculous prices and produced massive debt.

For the most part, investors have given satellite a long honeymoon. But for the first time in its five years on the air, both services are seeing subscriber growth rates slow and begin to level off. This is exactly what investors have feared the most: the lofty projections of the number of anticipated XM and Sirius subscription sales may be more smoke and mirrors than real.

Wall Street has hammered both companies' stock prices downward over the past year. Without sustained subscriber growth, neither will have a prayer of turning the corner of profitability.

BOGGED DOWN

Stern has had about eight months to lure as much of his old terrestrial audience as possible over to his new home. He had about 12 million daily listeners before moving, but his Sirius total appears to be slowing down at about 1.6 million subscribers. Analysts have reported that Sirius would need at least 3 million Stern subscribers to break even. If it doesn't happen during the first year, it's probably not going to happen.

The big marketing blitz is over as most Stern fans have already decided to pay the money and follow him or stay with other free alternatives on terrestrial. That's not good news for a company that pinned much of its expected growth on one show.

Add to the mix the recent move by Opie & Anthony coming back to CBS Radio to shore up the loss of Stern's syndication, a striking turn of events for a company that had fired them only two years ago over the sex-in-church caper.

Opie & Anthony had been toiling away on XM out of earshot from the vast majority of radio listeners. In only a few Arbitron surveys, they've already delivered impressive gains for many markets that were feeling the pinch of losing Stern, such as Philly, New York and Boston.

Stern can't be very happy about Opie & Anthony and his former network dancing on his terrestrial grave, carrying his old party forward.

SURVIVAL STRATEGIES, REALITIES

Both Stern and his boss Mel Karmazin at Sirius have got to be thinking how they could re-leverage Howard back into terrestrial radio if indeed his new subscription rate slows and stops growing.

Radio has always been a house full of strange bedfellows. Don't be surprised to see Stern show up on terrestrial again. That would surely not make those 1.6 million fans who pay extra to hear him on Sirius very happy.

The only other options to stop the bleeding are to raise the subscription rates and sell more commercials on Stern along with other Sirius channel offerings. Too many ads are a headache that the majority of folks who pay to listen to radio want very much to avoid, and such a strategy easily could trigger mass cancellations.

Satellite certainly has established a solid fan base and serves a valuable function in the U.S. radio marketplace. But the hill that both satellite radio services are climbing toward profitability seems to be getting steeper every day. Aside from slowing subscription rates, the RIAA is proposing big increases to both for music royalty fees, resulting in XM pursuing an expensive lawsuit over that issue.

XM is now facing a new round of FCC problems, with thousands of radio converters that cause too much FM band interference. Add to that allegations that Sirius may have intentionally published inaccurate specs on its converters showing they met the interference limits when in fact they did not.

If that wasn't enough, a key XM board member resigned earlier this year citing internal mismanagement and a possible looming financial crisis at the company.

The satellite service is obviously moving into a new phase of its evolution. It's been playing a game of beat-the-clock from the beginning. Time just might be starting to run out.

As with any other high-tech venture that over-promises and under-delivers, investors eventually run out of patience and head for the exits. If current management teams cannot find a way to scale back expenses and increase revenue to keep the businesses growing, heads will roll. Changes at the top including a newly appointed COO were announced at XM in late July.

Mel Karmazin has been musing publicly about the prospects of Sirius and XM merging into one company in the future. Sirius has launched better marketing campaigns and has been adding new subscribers at a faster clip than XM since Stern came on board in January.

Karmazin certainly would prefer to acquire control of any new merged company. But XM is the much larger service of the two, and before stumbling a bit lately it seemed to have a better shot at eventually becoming profitable, albeit a long shot.

Karmazin probably wouldn't be talking merger unless he felt in his gut there wasn't room for both to become profitable and survive. Ostensibly, such a consolidation would allow one entity to be able to better manage their collective assets and reduce liabilities to allow an independent satellite service the rights of survival. But FCC rules for the service were written to establish two separate companies to ensure a competitive environment. Changing those rules could be problematic.

HITTING BOTTOM

As year after year of red ink keeps flowing off their books, stock prices of XM and Sirius could easily plummet further. Eventually the liabilities could outweigh even the perceived value of the assets and the major stockholders would demand action. Either the controlling interests of each company would negotiate amongst themselves to restructure the assets and the business plan into something that would be acceptable to the owners who remain. Or, a Chapter 11 reorganization bankruptcy would proceed.

The major stockholders of XM include General Motors and Clear Channel Radio. Ford Motor Co. holds a large stake in Sirius. It's no secret that these U.S. carmakers are in financial distress. It's not unlikely that either could choose to spin off those interests if management decides their satellite radio holdings no longer hold enough potential value, and instead represent more of a liability adding to their already staggering company debt.

Such a decision would be akin to colleges and universities that find themselves beleaguered in debt and decide to sell their valuable NCE station licenses. Many such stations did not contribute income but instead were mostly a financial burden, even if they did provide a public service and PR function for the school. Somebody else with deeper pockets came along with a business plan and vision that could better harness the value and the earning power of the channel.

IN THE WINGS

A similar scenario could play out with satellite radio. Whom do you suppose would be very interested in buying the Ford and/or GM satellite holdings, should they go on the block at attractive prices? Why, terrestrial broadcasters, of course!

They are the wellspring for most of the content and talent that subscribers have always heard on satellite. They invented the art form and the substance of good radio. As terrestrial radio diversifies its own services with Internet streaming and HD multicasting, satellite would just become another component part of the burgeoning stable of products.

Most of the leading American terrestrial radio companies are churning out impressive cash flows and ROIs. They are mature businesses with solid balance sheets, manageable debt and long track records of financial success. Assuming FCC rules can accommodate it, who better than they to develop and manage properly the satellite offerings as part of the total radio package?

Before all you liberal anti-consolidation zealots scream bloody murder, fearing the airwaves would be controlled by even fewer players in such a development, take a deep breath, step back from the fray and consider this: Consolidation has allowed many of the more marginal terrestrial facilities to "stay alive" and serve niche audiences, including ethnic and minority group interests.

REWRITING THE PLAN

Competing effectively year after year in either the commercial or public broadcast arena takes money and expertise guided by a viable and realistic business plan. Group owners with more extensive resources than stand-alone operations are almost always in a better position to take risks and properly support format changes and start-ups that may lose money for some time before they develop into self-sufficient sustaining businesses on their own.

These companies do not harbor or promote some monolithic right-wing agenda, nor do they decide what's good programming without extensively researching and polling the needs and concerns of potential audiences. If a new format can attract significant listenership and have staying power, you will generally find it somewhere on the dial.

Should the satellite services be restructured and terrestrial radio become the controlling interests in their ongoing operations, it is quite likely there would be a consortium of companies stepping up to own a piece of the action, rather than one company attempting to acquire and control all of either sat service independently.

Public radio should be part of this new mix as well. More voices could potentially be involved in the decision-making of satellite programming and operations than we have now. The downside risks would be mitigated and spread out across multiple owners.

A LONG-TERM INVESTMENT

The HD rollout continues at a steady pace with more companies stepping up to equip their second-tier markets with HD and HD2 capability. Many major markets now feature virtually all of their major FM stations with HD. AM-HD adoption will remain slow and scattered until the rules allow full-time HD operations and the attendant fallout of interference is better known and eventually resolved.

It's becoming clear that the companies that invest in HD and install the gear and the programming to support it are in this for the long haul. From what we've seen, their owners and operators understand that commitment, perseverance and patience will be needed to promote the new services and allow HD receiver penetration to grow towards critical mass.

We won't see much movement in that direction until major car companies include HD and multimode radios as OEM equipment in new model cars. All indications point to 2008 for that watershed process to get rolling.

HD2 will most certainly bring many more format choices to the dial, giving listeners new options they could only find on satellite or manufacture themselves via CD and iPod collections. The real value of those additional channels will not be realized for quite awhile, however.

While many may start out as fully automated voice-tracked jukeboxes, programmers will dress them up to be worthy competitors to both satellite and their own main channel stations over time. Eventually many should emerge as full-fledged stations in their own right, competing head-to-head with their main-channel hosts.

REMEMBER FM STEREO

HD naysayers are still predicting that if HD receiver sales don't take off quickly, the service could easily falter and meet a relatively quick demise, similar to AM stereo. That's like comparing the rollout of FM stereo to that of FM quad. Music on FM already sounded good enough in stereo to most listeners while quad was deemed a gimmick for aficionados, little known to mass consumers. Like AM stereo, the industry really didn't need FM quad, it so it was largely ignored.

FM stereo, on the other hand, did make a real difference, although not an earth-shaking one at the time for the average listener. Like HD, it was an important technological innovation the entire industry embraced and supported. Stations installed stereo encoders, radio manufacturers integrated stereo reception into receivers at all levels and consumers bought them whether or not they wanted the new feature or were even aware of it.

From the time FM stereo standards were adopted in 1961, it took at least 10 years for the new mode to take hold in the marketplace and another 10 years before FM stereo became the dominant choice for consumers of radio entertainment.

The same pattern is likely to be charted by HD Radio. It's just going to take time to make it to critical mass. Along the way, the technology will no doubt continue to improve and refine its present offerings. New ones not yet even dreamed about will certainly be added. HD is much more than just your daddy's FM stereo.

But the conversion should not take as long this time around with the advantages of digital being so much more flexible and scalable. It can easily accommodate new payloads and features in the coded bit stream that were utterly unthinkable in the analog era. Both the transmission and reception ends of the process can be updated relatively quickly and efficiently.

There is no other transport option that makes better sense for the industry going forward. There is simply no turning back now.

RWEE welcomes other points of view to rwee@imaspub.com.

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