Founded in 1992, XM Satellite Radio (Nasdaq: XMSR) is one of two companies in the U.S. that hold exclusive licenses to offer a new kind of satellite radio services. Imagine 100 channels of digital music, news, sports, and entertainment beamed to your car for $10 a month and you get the picture. Now imagine turning on your favorite station in New York and hearing it all the way to Los Angeles on a cross-country trip. That's the power of satellites. The company expects to roll out service in the first half of 2001.

"As you know in the radio business, about 70% of the radio stations today use only five formats. It's very homogenized programming. And if you're an artist that doesn't fit into one of those formats you don't get a lot of airplay. But niche music makes up about 21% of all music sales."

President and Chief Executive Officer Hugh Panero spoke with The Motley Fool about the company's business model, market size, ability to generate revenue, and rollout plans.

TMF: Tells us about the radio service your company will offer.

Panero: We describe it as the next generation of radio. First there was AM, then there was FM, and now there's XM. Basically, the government auctioned finite amounts of radio spectrum. We intend to build out a national premium radio service offered to consumers for $10 a month. It will provide coast-to-coast coverage, digital-quality sound, and up to 100 channels of programming, much of which isn't available on traditional radio.

TMF: What kind of programming?

Panero: Well, it's funny. The word niche programming comes out a lot. It's obviously not niche programming to the people who love it. Our service will have about 50 or 60 channels of music, and 50 channels of news and information. As you know in the radio business, about 70% of the radio stations today use only five formats. It's very homogenized programming. And if you're an artist that doesn't fit into one of those formats you don't get a lot of airplay. But niche music makes up about 21% of all music sales.

So we can take formats like jazz, blues, classical, alternative rock, hard rock, or mellow rock, and have channels dedicated to them. I've been around the country either raising money or just visiting various suppliers or backers, and it's amazing. What you find is a very diverse group of individuals, and just because a local community doesn't have a local ad-supported commercial radio station around formats like classical jazz or blues doesn't mean that no one listens to it. We're just bringing another tier or option of entertainment into the car. It's very similar to what consumers experience either on the Internet or in their homes with television.

TMF: Won't it be difficult to sell advertising on these stations? Rhythm and blues listeners would love to get a channel devoted to that format, but how many advertising dollars are you going to be able to bring in?

Panero: Some of our channels will be commercial-free. Some of them will be sponsored by companies. Just imagine a Harley Davidson (NYSE: HDI) hard rock channel or a Pepsi (NYSE: PEP) top 40 channel. We'll only have about six minutes of ad time an hour on average, compared to 20 minutes on a commercial station. It's a combination of different advertising models that suit different genres, but you're right. On the classical station there won't be advertising or it'll be something much more sponsorship-like. But on a rock channel I think people want some in-your-face kinds of programming. You know, people aren't opposed to advertising, just a lot of it and big blocks of it. Some of our most successful businesses are ad-supported right now.

TMF: You're building two geosynchronous satellites and a ground spare, right?

Panero: Yes, and a network of up to 1700 terrestrial repeaters that cover the top 70 radio markets.

TMF: What are you looking at for build-out costs?

Panero: Well, basically satellite systems like this are $1 billion-dollar investments. That cost includes everything. Build and launch costs are probably in the $500 million range, but total XM capital needs include your satellite infrastructure, your terrestrial infrastructure, your marketing programming, billing system, and all of those things. What's attractive about the system is that the costs to get your first customer, or your one-millionth customer, are the same.

TMF: Because the satellite coverage area blankets the whole country?

Panero: What made satellite television so attractive is that in the cable environment every time you wanted to build out a new area you had to go wire another part of the city. Obviously with a satellite system you have a ubiquitous distribution platform.

"We're talking about a service that's predominately geared toward the car, which is a captive environment, where little technology has been introduced and where people are spending more time than ever before."

TMF: What are you looking at as far as the size of your addressable market?

Panero: There have been several studies done. It looks like there are between 34 million and 43 million households of people who are willing to pay $10 a month for a subscription radio service that would offer coast-to-coast coverage. Of that we need about 4 million to reach EBITDA [earnings before interest, taxes, depreciation, and amortization] breakeven.

We'll launch the service in the second quarter of 2001. We hope to reach our breakeven number of four million by 2004. Many of our projections were made by companies that predicted the growth and size of the satellite television business. Some of the reactions from the research that's been done actually show even more excitement about this product.

TMF: One of the reasons Iridium (OTC: IRIDQ) got in trouble is because it had so much debt to pay off so quickly. Are you in a similar position or do you have some breathing room?

Panero: No, we're talking about completely different animals. Iridium was an international telephone service that had a promise of delivering a call anywhere, anytime, anyplace in the world with a $3000 telephone. It had to launch 50 or 60 satellites.

They were reinventing everything. With ours we are going into a proven market where there are examples of various other companies that have done the same thing. In terms of just the economics of what we have, we have raised $500 million of equity and now we're leveraging that to get debt. And also Iridium was a big consortium that was led by a hardware manufacturer [Motorola (NYSE: MOT)] that was probably more interested in selling devices than really understanding what the consumer demand was for their product.

We are a much more entertainment-, consumer-, market-place-driven service because we're not making the hardware. We're leaving that up to companies like Alpine, Pioneer (NYSE: PIO), Sharp (OTC: SHCAY), Mitsubishi (OTC: MSBHY).

TMF: You'll have to be signing up a certain number of customers in order to start making some payments, but you don't feel like your back is going to be against the wall?

Panero: No, because right now all of the money in the company is equity. Where we raise debt is either going to be high-yield debt or some other public or private debt. We're trying to figure out the best way to go.

TMF: No question it's a compelling business model, but what if somebody says, I'm already paying a monthly bill for cable. I'm paying a monthly fee to get some extra satellite channels. I'm paying a monthly fee for phone and wireless, and now I've got Internet and broadband coming. I just can't handle one more monthly payment.

Panero: Well, people always seem to have the capacity to spend more on these things. You're right, at some point in time there is discretionary income, but where is this service focused? If we were another service trying to go into the home, where there are 15 different kinds of technologies trying to get at that consumer, you might have an argument there.

But we're talking about a service that's predominately geared toward the car, which is a captive environment, where little technology has been introduced and where people are spending more time than ever before. There's a study that came out recently that showed over the last 15 years, people are spending 235% more time on the road in their car.

TMF: More if you live in Washington.

Panero: Over that same 15 years the population has only increased 22%. So basically what you're finding is that people have always had a [traffic] problem in Los Angeles or New York, but now because of urban sprawl [you see it in] Washington, D.C., San Antonio, Denver. In our situation, the radio business, traffic is a good thing. It basically creates a motivation for people to want more entertainment and companionship in their cars.

I think if we were just another service being layered into the home some of your issues would be right. People are fighting through a cable television bill, but the car's a very unique thing and I think you are going to find that a lot of industries are going to be focusing attention on the car because of its uniqueness.

TMF: How about the radio? Do I have to buy a new radio to get the service? And where will I do that? Are you going to have to plug in adapter so I can convert my existing radio?

Panero: Yes, we're going to have a little bit of everything. First of all, each year there are 23 million new car radios sold to the American public. Seven and a half million are sold through what is called the car after-market. Another 15.5 million new car radios are sold as part of the sale of a new car every year. In those two worlds, we have very significant partnerships. On the after-market side, we have agreements with companies Alpine and Pioneer, which represent about 31% of the sales. On the equipment manufacturer side we have a 12-year exclusive agreement with General Motors (NYSE: GM) to distribute and market our radios and our service in their cars. We also have a manufacturing agreement with Mitsubishi, Clarion, and Motorola. In the home category we have a relationship with Sharp, and we're also developing a plug-in play device.

TMF: What is the price on one of the after-market radios?

Panero: As with most consumer electronics equipment, the price of the actual radios will be dependent on the features. It will add about $150 to the cost of a radio. In actuality what we're doing is really building an XM Satellite radio and adding on the other features.

TMF: How are we going to buy these radios? From Best Buy (NYSE: BBY), Circuit City (NYSE: CC)?

Panero: It's really interesting. I don't know how much you know about the satellite television business, but there was really no distribution network that existed to distribute these new satellite set-top boxes.

In our case we are plugging into an existing distribution pattern that has been going on for quite some time where there are always about 7.5 million people who replace radios. When you are in the consumer electronics business, you'll pay more for a new device that'll add some new features. So we're just offering this new feature set. So first of all, all of those radio manufacturers that we have relationships with have ongoing, long-term relationships with all of those retailers, but then we're also talking to those retail outlets about developing a relationship because we expect many of our sales are going to come through that outlet.

Basically, people will be driven to buy the devices through the Internet or going to a very well-known consumer electronics retail outlet. You're going to go in there and there's going to be a shelf full of products. You'll buy the radio. The salesman will at the same time be selling the service base on some kind of commission program. And we're basically following an existing distribution network that people like EchoStar (Nasdaq: DISH) and DirecTV [a division of Hughes Electronics (NYSE: GMH)] pioneered. It's great for us to be able to piggyback on that experience base. As you know from reading our material, our company is owned by some very, very powerful and strategic partners such as General Motors -- the largest car company -- Clear Channel (NYSE: CCU) and DirecTV, who is the largest satellite television provider in the United States.

TMF: Since you can't beam satellite signals through trees or bridges or hills, what about line-of-sight issues?

Panero: I was going to add on lions and tigers and bears there. Basically, you can have signals that can go through certain types of foliage. Obviously it's not going to go through the Amazon canopy. That's why we have our terrestrial network which will augment the satellite signal in urban environments where you have tall buildings that can create certain blocks.

We're working with Hughes Network Systems [a division of Hughes Electronics] which is going to build the hardware. You overlay a software program that takes into account topography, calculations on signal strength, etc. We've actually pinpointed a number of repeaters that we need per market. The thing that's different between our service and a cellular system is that those systems are not usually overlaid with a satellite signal. So you don't need as many repeaters with our network.

On the programming side, which is something we haven't talked about yet, we'll create a large number of channels internally under the banner of XM originals that will be created by some of our radio programming professionals. Some of these guys are pretty well known. We have also done partnerships with people that we think are great brand names or have a really true expertise in a certain field. We're going to carry Bloomberg, CSPAN, CNNfn, and even big radio companies like Hispanic Broadcasting Corporation. They'll create five channels for us. Black Entertainment Television will create four urban channels. We'll have a service that combines a lot of original programming, some of it commercial-free, some of it ad-supported with very well-known brand names and with industry-experienced partners who know how to reach out to a particular audience.

TMF: Where are you going to roll out the service first?

Panero: I don't really want to outline our rollout strategy. I have a competitor out there who watches everything I say [Sirius Satellite Radio (Nasdaq: CDRD]. Let's just say that it's going to roll out nationally in markets where consumers are going to be clamoring to get the product.

TMF: The last thing. The bulk of your revenues will come from subscription rather than advertising?

Panero: Well, initially a revenue split will probably be more like 90% subscription to 10% advertising. But after about five years it'll probably be about 60% subscription, 40% advertising.

TMF: Good luck to you. I hope the business takes off.

Panero: Bye.


Related links:

• XM Satellite Radio Home Page
  
• Sirius Satellite Radio StockTalk
  
• XM Satellite Radio Message Board