RSSMore Realities on Sirius
By Mike Stathis | July 10, 2008 | 9:09 PM | 0 Comments
If you have read my previous articles on Sirius (NSDQ: SIRI) and satellite radio then you already know why the numbers just aren’t there. Here, I focus on management’s highly irresponsible expenditure of capital.
Unimpressive Content
While paying for a service consisting of 136 commercial-free radio stations might sound like an attractive deal, the only thing attractive in my opinion is the commercial-free part. Of course everyone is different. As for myself, I found only 6 stations I would listen to (2 music, 1 entertainment and 3 news). But these stations are not that unique and I can find similar ones on my normal free radio. As far as the big bet by Sirius, Stern, I am from the old school of former Stern fans who stopped listening to him long ago after he turned his content 180 degrees as a way to reach a mainstream market. In my opinion, Stern’s content has declined dramatically from his more humble early days.
"It's been a great year and the show is better than ever," Stern said. "I can do whatever I want and say whatever I want." Perhaps that line was texted to him by his agent or a PR spokesperson from Sirius.
Is that so Howard? I remember the days when you couldn’t say what you wanted and your shows were 10,000 times better. You were creative and innovative. Now you are just a thumbtack on the wall. It appears to me as if you have sold your soul for money. And your programming content supports this premise. On a more personal note, I find it unfortunate that you lost your wonderful ex-wife in this process of your transformation into mainstream media - the lady that stood by you for years when you were struggling; the lady that may in fact been largely responsible for where you are today through were continued support.
Many of you may not realize this unless you happen to live in NYC, Philly or a few other cities, but Stern’s best days were in the early 1990s, when he actually had original entertaining content. Ever since he began his amazingly boring, repetitive and ridiculously stupid TV show on E!, which in my opinion officially marked his decline. Apparently, viewers weren’t impressed either since the show was pulled. Today his radio show continues the same old boring predictable content – stripper talk, boob talk, and trash. Stern sold his soul for big bucks. And in the end only he and the CEO of Sirius will cash in.
Stern exemplifies what happens when you lose your passion from enormous sums of money. We see this everyday – in sports, in business, in everything. There is always a balance in life. And when this balance is shifted to favor huge sums of money, it usually results in fraud, waste, or simply poor performance. You don’t need to perform when you have guarantees of hundreds of millions. That does not represent capitalism. It represents shareholder abuse.
Has the Gamble on Stern Paid Off?
I’ll let unbiased readers decide. Since Stern joined Sirius the stock has dropped from just under $7 to $1.95. While subscriber growth has improved, we must question how much of this subscriber growth has been attributable to Stern. When one considers the enormous sums of money spent for marketing, and the fact that XMSR has more subscribers, it is easy to conclude that Stern may have contributed a couple of million to the numbers but his reach has been saturated. At what expense is Sirius willing to pay for subscribers? I suppose when you have limited creativity and no sense of strategy you will pay top dollar. The bottom line is that the company continues to struggle.
Irresponsible Use of Capital
In 2006, Sirius paid Stern a total compensation of $302 million. In total, estimates range anywhere from $500 to $700 million for Stern’s gross payout depending when he sold his stock. It is difficult to know how much stock he owns at this point since he is not required to disclose his sales. However, we do know that he has sold at least 17 million shares. I would be willing to bet he has since sold much more. If I was an investor in Sirius, I would want to know how much stock Stern still owns.
Robbing Shareholders
Prior to the 2004 debt for equity conversion, I recall that Stern and the CEO accounted for a huge percentage of the outstanding shares. When I saw this, I pretty much knew the fate would not be good. After the huge debt-for-equity conversion, their fate was sealed as far as I was concerned. But Stern wasn’t the only one to catch a ride on the shareholder gravy train. As of December 2004, Karmazin's Sirius options were worth $240 M (Reuters). Cash compensation and stock options for Karmazin in 2006 totaled about $100 million.
Someone tell me how Sirius can justify paying the CEO $100 million in annual compensation when the company has yet to record a profit. The wave of ridiculous CEO compensation in America is already out of hand but this is criminal in my view. And in 2007, his compensation was $32.1 million, much less than previous years but still more than the compensation package of the entire executive management at XMSR. I would estimate Karmazin’s total compensation since being involved with Sirius to be at least $300 million.
The 14A Sirius Filing for July 2007. An excerpt from a 10-K/A SEC Filing, filed by Sirius Satellite Radio Inc on 4/29/2008. As of December 2006, the value of Chairman Joseph Clayton and former CEO of Sirius (2001-2004) was $82.6 million (stock options). If you recall, this man was President of Global Crossing North America (1999-2001) - the telecom company involved in one of the biggest accounting scandals of all time costing shareholders billions. Remarkably, no one from the Global Crossing served jail time and only very tiny fines were imposed on a few executives. If you recall, Global Crossing was also a stock held by many unsophisticated investors.
Combined, the payouts to the executive management and Stern alone are likely to have surpassed $1.0 billion since 2001.
Massive Debt to Stock Dilution
On March 7, 2003, the company completed a series of transactions to restructure its debt and equity capitalization. As part of these transactions:
• Sirus exchanged 545,012,162 shares of the company's common stock for approximately 91% of its outstanding debt….
• Sirus exchanged 76,992,865 shares of its common stock and warrants to purchase 87,577,114 shares of common stock for all of the company's outstanding convertible preferred stock;
• Sirus sold 24,060,271 shares of its common stock to affiliates of Apollo Management, L.P. for an aggregate of $25.0 million in cash;
• Sirus sold 24,060,271 shares of its common stock to affiliates of The Blackstone Group L.P. for an aggregate of $25.0 million in cash; and
• Sirus sold 163,609,837 shares of its common stock to affiliates of OppenheimerFunds, Inc. for an aggregate of $150.0 million in cash.
Rinky-Dink Strategy
In a previous article, “Satellite Radio Faces Enormous Challenges,” I discussed several barriers faced by this industry. Now I will list some of the additional hurdles that will be raised due to the weak economy.
• Banking on a US auto manufacturer to push your radio in new cars isn’t exactly the best strategy especially when this auto manufacturer has continued to lose market share for well over a decade and now faces a possible bankruptcy.
• There is an increasing trend of more people taking the bus and rail over driving. According to surveys, as gas prices increase, even more will turn to these forms of transit. And if you think oil prices aren’t going higher you really need to wake up.
• I find it troubling that continued declines in new car sales would impact Sirius subscriber growth. What that means is that they are relying on auto makers to push the service in the face of consumers. If Sirius was a service people wanted they would be going to Sirius and asking for it. This cheap tactic, taken from Bill Gate’s plastering of Explorer along with Windows simply isn’t going to work.
Sirius’ Earnings Nightmare
If the company ever turns a profit you can bet with 1.5 billion shares outstanding the EPS is going to stink for a very long time; that is unless they do a reverse split. Let’s take a look at the number of shares outstanding for some other companies and compare them to Sirius’ $1.5 billion shares outstanding.
• Apple (NSDQ: AAPL) – without looking, can you guess how much this media powerhouse with its $150 billion market cap has outstanding? Try 881 million shares and no debt.
• Google (NSDQ: GOOG) – with a market cap of $150 Billion, the company only has 314 million shares outstanding and no debt.
• Yahoo (NSDQ: YHOO) – with a market cap of $28 billion, Yahoo has 1.38 billion shares outstanding and $583 million in debt (a very small debt-to-equity ratio).
• Comcast (NSDQ: CMCSA) – with a market cap of $55 billion and decades of operating, this media giant has 2.96 billion shares outstanding. With over two decades as a public company, Comcast has gradually and responsibly issued more shares according to earnings growth, unlike Sirius which has issued shares irresponsibly.
• Merck (NYSE: MRK) – with a market cap of $83 billion, the company has 2.15 billion shares outstanding and has been in one of the top performing industries over the past two decades.
The list goes on and on. Have a look for yourself. The more you look the more you will realize that in the best of scenarios, Sirius will not perform well as an investment and has a high risk of folding. Now as far as the proposed merger, a combined XM-SIRI entity will still have the stock dilution created by the “prudent” management of Sirius. As a result, while some cost savings would be realized by the merger, the fundamentals of the industry make it unlikely that either of these companies will be around in a few years. I am surprised class-action lawsuits have not been filed yet.
Duped by Merrill
Those of you who put much credibility behind Sirius’ merged financial projections and Merrill’s research need to keep a few things in mind.
First, I will bet anyone any amount of money, Sirius management has not adequately discounted any projections based on the realistic expectations of the economy. How can I be so sure? Because there are only a handful of people in the nation who understand what’s going on with this credit crisis. And I do not know anyone in corporate America who is included in this small list. If the guys running the biggest banks and Wall Street firms don’t know what’s going on do you really think Sirius management does? These guys can’t even execute (in a space with only one competitor) sufficiently to turn a profit even after eight years.
Second, for those who are speculating in Sirius, are you sure you know how to value Sirius or an XM-SIRI merged entity? What valuation method would one use? If you said Discounted Cash Flows (DCF), you are not only wrong but you get an F. Now, the fact is that anyone who uses the DCF method to assess valuation to SIRI, XM, or the proposed XM-SIRI merged entity will yield valuations that are highly suspect at best, and dangerously wrong at worst. And that includes Sirius management and Wall Street analysts. I find it laughable that the latest research from Merrill showing projections was based on the DCF method. In fact, I’d be willing to bet that nearly all of the analysts have used this method for Sirius and XM from day one. And that would explain why they have continued to be wrong.
You can’t exactly discount future expected cash flows when you have had none in the past. Anyone competent in valuation analysis will tell you that the DCF method serves as a good way to measure valuations of companies with positive cash flows. It becomes less accurate for companies that have negative cash flows, new companies with large earnings volatility, when companies are distressed OR undergoing restructuring, or when they derive a significant portion of revenues from intellectual property – all four conditions met by Sirius. Distressed companies have more internal issues that can result in negative cash flows. And because these companies face a good possibility of bankruptcy, it is extremely difficult to determine whether they will ever have any positive cash flows. In such cases, it is very important to understand the company’s ability to secure lines of credit and restructure debt covenants so that the company can weather the difficult period. Needless to say, Sirius isn’t exactly going to receive the red carpet treatment when looking for more credit from banks. The banks have problems of their own. The last things they want to do is make more bad loans. But there’s always Wall Street, right? Given the current conditions, I can’t see how they would be able to find many investors willing to buy Sirius debt. And a merged XM-SIRI would be even worse since XM needs to refinance several hundred millions in debt.
Despite drawbacks for these types of companies, Wall Street uses the DCF method more so than any other, for reasons I do not wish to get into right now. It is certainly possible to derive a valuation in some cases when cash flows are not positive or highly predictable. But there will be a very high error rate and this must be addressed in any valuation. Calculating a present value for companies with negative cash flows, by necessity, results in a negative equity valuation for the company with the DCF method. Thus, the approach must be modified when applied to such companies. When cash flows become less predictable, the discount rate is larger to reflect this uncertainty. And larger discount rates are associated with lower degrees of accuracy with this method. So you need to focus on the assumptions made that went into determining the discount rate. Have they adequately accounted for the high level of uncertainty? I would expect a research report that used the DCF method for Sirius or XM to be almost entirely focused on the assumptions made and risks of cash flow predictions. Finally, when attempting to use the DCF approach for newer companies, the measurement of the discount rate is theoretically not feasible due to the various uncertainties to be expected with newer companies. Nevertheless, many analysts estimate discount rates based upon the company’s size and applicable industry and make adjustments for more specific factors. There are some newer companies that can be valued using the DCF approach legitimately, but only they have a history of predictable cash flows. However, in general, companies considered high growth (typically high tech) would be excluded since they typically have high costs and a higher risk of earnings and revenue growth. One can perform a better analysis by understanding industry dynamics, estimating subscriber growth and watching the company continue to burn cash like its endless.
Conclusions
I would love to see a successful commercial-free radio network. It is desperately needed to severe the close ties between the media, Washington, Wall Street and corporate America. But as I concluded in my previous article, “Satellite Radio Faces Enormous Challenges,” it always comes down to management. And that does not bode well for Sirius. The Chairman is suspect at best due to his involvement with Global Crossing. And similar to Stern, Karmazin’s best days are way behind him. Karmazin exemplifies everything that is missing in traditional media. This is an industry struggling to find ways to deliver value while other companies like Apple and Google continue to lead the new media revolution.
Sirius would be best served if management hired an expert strategist and marketing firm – and I mean guys who know what’s going on and guys who can deliver results. Even with the best of management, the industry fundamentals combined with competitive threats and financial vulnerability of Sirius or even a combined XM-SIRI entity do not stand much of a chance of long-term success. If in fact the merger does go through, I would advise XM management to run the show. They clearly understand how to more effectively use capital and grow subscribers without giving away a half of the company to a few individuals.
I don’t care what the end result ends up being. If you can’t see that this company has pulled every dirty trick out of the book to make it to the next stock option payday then you are naïve. This company has the ingredients of companies that file for bankruptcy. But at least most companies that file for bankruptcy have a history of profits. Sirius has abused the Wall Street mechanism, making huge bets, paying out hundreds of millions to its CEOs, Stern and others, and diluting shareholder equity in a manner similar to what I have seen done with bulletin board and pink sheet stocks.
By the time Sirius is finished, it will have effectively transferred executive pay, Stern and other hosts’ pay, the payout for auto makers and the ineffective marketing from the hands of shareholders. With a current market cap of $2.9 billion, after adding up the costs mentioned above, maybe you can begin to see what I am saying. Sirius shareholders have thus far financed the gravy train for everyone but themselves. In all my years as an investment professional, I cannot recall another company acting more irresponsibly with shareholder equity as has Sirius (excluding pink sheet and bulletin board stocks). This is a prime example of lack of fiduciary responsibility that has resulted in the poor making the rich even more wealthy. It’s really a sad situation to behold.
These are the real issues that should be highlighted when the media mentions Sirius, not some speculative forecasts, which as we have seen over and over, rarely pan out. When you have invested in a company that has done little for eight years, burned through cash irresponsibly, and is absolutely dependent upon a merger for the slightest chance of survival, you had better not take what management or Wall Street analysts say at face value. You need to make certain their methods, along with all assumptions make sense.
Now the Good News
If this merger does go through, it is likely to move both stocks but I would consider using this short-term bounce as a means to exit. Collect your cash, set back, relax, and wait. Watch how things play out and only get back in at a later time when things look a lot better. Don’t let greed get to you. It’s always better to have more certainty and miss a few points on the upside than risk losing it all.
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