Karmazin's task: Selling satellite radio to investors
With the once-improbable merger of XM and Sirius near completion, the consummate salesman needs to persuade Wall Street that satellite radio has a future.
NEW YORK (Fortune) -- Mel Karmazin has proven throughout his career that he's a world class salesman. But with the merger of the nation's two satellite radio broadcasters Sirius and XM nearing its once-improbable completion Karmazin has a real sales challenge: Convincing investors that there's a profitable future ahead for a medium that has conspicuously failed to turn a profit at any time since it was founded a decade ago.
Until now, satellite radio has depended on subscription fees to service the huge debt it has piled on to build out its business, but investors and even the companies recognize that they must find more sales avenues to have any hope of turning a profit.
As a service, the $13-a-month, 100-plus-channel programming has its fans. The combined company also has 17 million users - if you count new cars on dealers' lots. But it has never had a winning business model. In fact, the two companies have operated with staggering losses. At the end of 2007, the combined accumulated deficit for both companies was a deep pool of red ink totaling $8.6 billion. And last month, both companies stopped offering any financial guidance or predictions on when or if the business could swing to a profit.
One option that could open a spigot of revenue -- an approach that Karmazin, who will serve as CEO of the merged operation, has known since he was 17 -- is to sell radio ads.
Analysts and investors viewed Karmazin's arrival in 2004 as a sign that Sirius (SIRI) was entering maturity. Karmazin's media industry savvy could help bolster the subscription revenue model with a second prong: ad sales. Under Karmazin, ad sales eventually grew to about 4% of all revenue.
A Sirius representative said the company hopes to make advertising 10% of total revenue. As the combined company gets closer to 20 million subscribers, it becomes a "tier one" player and "able to charge more and get more money" from advertising, the rep said. "Our goal is to have a dual source of revenue."
The Sirius chief has had some practice in the art of selling. He ran Infinity broadcasting for 15 years and sold it to CBS, then sold CBS to Viacom (VIA) for $37 billion. He joined Sirius in 2004 and sold it to Wall Street as a new digital media for the mass market, rather than a cash-burning furnace. He sold Howard Stern on the idea of leaving free radio and his 12 million -- according to one count by the LA Times -- fans for the artistic freedom of an unregulated format enjoyed by hundreds of thousands of paying customers. (A $500 million pay package didn't hurt.) The Stern deal was one of Karmazin's first moves and tellingly, it included an ad revenue sharing arrangement with the shock jock.
Now, Karmazin is poised to close his biggest sale of late: The merger of two companies that had a no-combination clause written into the terms of their licenses. The Federal Communications Commission is expected to approve the deal in the next few weeks. Analysts expect its OK will carry some conditions like price caps, combined programming packages and possibly a requirement to reserve some channels for outside media or divest some small portion of its airwaves.
But does a win in satellite radio really count as a win?
The need to diversify revenue streams has become increasingly evident. New user signup rates have dropped dramatically from their peak in 2004, and without sky's-the-limit growth prospects, the companies' glaring cash consumption and huge ongoing financing needs scared investors away. The stock trades at $3.09, or about 5% of its peak value of $63.25 in 2000.
To make matters worse, Karmazin must now navigate his way through a rapidly weakening economic environment and much less friendly credit markets too. Consumers focused on the price of bread and milk are likely to be less interested in paying for premium radio. And lenders are likely to force higher interest rates on Karmazin, if he attempts to refinance about $1.5 billion in XM (XMSR) debt, and seeks additional financing for continued operations, as analysts expect.
The pressure could be enough to push Karmazin into an ad selling frenzy -- or at least that's the hope of long-suffering investors.
As the recipient of a brand new gift - a monopoly on the national satellite radio market - it is easy to see how appealing the advertising opportunity would be. Not only does satellite blanket the country and serve largely affluent customers, the format has ideal niches for very targeted ads.
There is a rub here however. Satellite radio's pitch has typically been a commercial-free departure from conventional radio. The company says it plans to keep its music channels commercial free. Channels like talk radio, news and sports have carried ads, but there's been little if any advertising on the music channels, at least to date.
"If that is the growth plan, then there is a problem in the road ahead," says one former Sirius and XM investor. "I find it hard to understand why people would need to pay for radio if they're going to be deluged with the same ads that made them shift to paid radio to begin with," the money manager added.