Satellite Killed The Radio Star Two upstarts, Sirius and XM, plan to rock the radio world. Will their satellite-based service be the next DirecTV or the next Iridium? Stay tuned.
By Bethany McLean

(FORTUNE Magazine) – One month ago, Sirius Satellite Radio launched its third satellite into space from the Soviet Union's once secret Baikonur Cosmodrome in Kazakhstan. As any space historian knows, Baikonur is where Sputnik was launched in 1957 and where Yuri Gagarin, the first human to orbit Earth, blasted off in 1961. Sirius is hoping for just a touch of the same transformative magic. This year the Manhattan company and its competitor, XM, based in Washington, D.C., plan to begin broadcasting 100 channels--from gospel music to heavy metal, from sports to science news, from CNBC to NPR--to cars anywhere in the country. The programs will boast CD-quality sound and few if any of those awful ads that can make it seem as if a carnival barker had crashed your car pool. Instead listeners will, for the first time ever, pay to listen to the radio in a car, with a $9.95-a-month subscription fee. "This is a once-in-a-lifetime opportunity to truly reinvent radio--across America," says FM radio pioneer Lee Abrams, 47, who works for XM. If Abrams is right, Sirius and XM may rattle the nation's $17-billion-a-year radio industry the way those early Soviet space successes shook America's psyche four decades ago.

The FCC granted Sirius and XM licenses in 1997 to use a portion of the S-band spectrum for satellite radio, and in the past few years the concept has won some big believers. Corporations including General Motors, DaimlerChrysler, and Clear Channel, as well as financiers like Sid Bass' Prime 66 Partners, Apollo, and Blackstone, have sunk almost $3 billion into Sirius and XM. Most of the top automakers have also struck agreements with either Sirius or XM to install satellite radios in their cars as early as this summer. Analyst William Kidd at CE Unterberg Towpin, who calls satellite radio "the next major consumer phenomenon," predicts that it will generate up to $10 billion a year in revenues by 2007.

But neither company has earned so much as a penny in revenues yet, and skeptics aren't hearing the music. Indeed, satellite radio could be, quite literally, a pie-in-the-sky dream--one that may end up more like the next Iridium (Motorola's satellite phone fiasco) than the next DirecTV (Hughes' wildly successful satellite-TV operation). After all, the technology (which really is rocket science) may not deliver on its promise of stellar sound anywhere, anytime. As for the crucial question--will people actually pay to listen to the radio?--well, there's no way to know for sure until you ask them. In other words, this is a hell of a gamble--one that may pay off for both, one, or neither of the two companies.

David Margolese, Sirius' 43-year-old CEO and the owner of 13% of its shares, doesn't look like a guy out to rock the entertainment world. Slight, with dark, straight hair and black-rimmed glasses, he's formal despite his black jeans and blue button-down shirt. He's not obsessed with using new forms of communication. Quite the opposite. He has no e-mail, no voice mail, and no computer, and until he got married last year, he had no TV. "If I live for 5,000 years, I might have time for TV," he says. "But I'd rather stare at the wall and think."

But when Margolese starts talking numbers, you begin to see how he persuaded all those bigtime investors to fork over $1.5 billion. There are 200 million cars on American roads today, and another 15 million or so are sold each year. Despite radio's antiquated image, some three-quarters of people over the age of 12 listen to the radio daily--and almost 90% of those who commute by car tune in for at least 50 minutes each day, according to the Radio Advertising Bureau and media research firm Arbitron.

If the math behind the business will work at all, it will work beautifully. While satellite radio does require massive up-front expenditures--Margolese will spend the $1.5 billion he raised and more--the cost barely budges whether Sirius gets one million or ten million subscribers. The ongoing operating costs are quite low--Margolese claims that Sirius can break even on a cash flow basis with as few as two million subscribers, or just 1% of the existing market. At that point additional subscribers are almost pure profit.

Margolese seems driven more by logic than by passion until he's asked a simple question: Why on earth would people ever pay for what they can get free? That's when his excitement breaks through his reserve. He grins, wrinkles his nose, leaps up, and runs across the room to grab a bottle of water. "You can get it for free, right?" He adds, "TV is free, but 70% of consumers choose to pay for cable--and another 10% pay for satellite TV." The key, as he points out, is that cable and satellite TV offer content that consumers can't get on regular TV. "We will be a quantum order of magnitude better than radio," promises Margolese, who never displays a trace of anxiety. "Once you try it, you won't go back."

In fact, Margolese says, "lightning struck" when he first heard about satellite radio. And he knows what it's like to receive such a bolt. Canadian by birth, Margolese dropped out of college in 1978 to found a Vancouver-based paging company. A few years later he came up with a plan to acquire the licenses to Canada's cellular phone rights. He joined forces with others, including Ted Rogers of Rogers Communications and the Belzbergs, the once feared Canadian corporate raiders. "David knows what he wants, and he focuses all of his attention on it," says Mark Belzberg. That partnership was the beginning of what is now Rogers Wireless, Canada's largest cellular company. In the late '80s, at 31, Margolese sold out to become a venture capitalist.

It was in that capacity that he met Robert Briskman, an early engineer at NASA and the former operations chief at Geostar, a satellite messaging company that went bankrupt in 1991. Briskman had designed the core technology for satellite radio, and he and other ex-Geostar employees had started a company named Satellite CD Radio. Margolese initially invested $1 million and soon decided that this was the best business he had ever seen. "I thought about it and thought about it and thought about it," he says. "I was very concerned that I was overlooking some flaw, but it is what it is."

On paper the business plan may indeed seem flawless, but executing it hasn't been easy. In 1994, Margolese estimated that satellite radio would be operational by 1997 and cost some $500 million. Not even close. One immediate problem was fierce opposition from the National Association of Broadcasters (NAB). Margolese recalls NAB filings predicting that kids would get killed on the way to school by a tornado they didn't hear about because the local radio station was out of business. (The NAB denies making such a claim.) It wasn't until 1997 that the FCC finally auctioned off the spectrum, for which Sirius paid $83 million. "It's been ten years, and I really feel like it's been 20," Margolese says.

There's no hint of that long struggle at Sirius' new headquarters, 37 floors above the bustle of Midtown Manhattan. The $38 million space, which Margolese designed, is all ultramodern hipness: clean blond wood, stainless steel, spotless white walls, and planes of glass. On one side of the soaring, atrium-like entrance is a music studio with a photo of the New York skyline at sunset; on the other side is a control room with a huge black screen that tracks the paths of the three orbiting satellites. Margolese insists that the access to artists that the location provides--Emmylou Harris came by after her appearance on the Letterman show; Sebastian Bach wandered over after finishing a Broadway performance in Jekyll & Hyde--more than justifies the cost of 150,000 square feet of pricey Manhattan real estate.

The showcase space is designed to do more than lure the glitterati, however. To succeed, Sirius must create content that compels people to tune in and pay up. That takes serious tools, including state-of-the-art networking and recording equipment, some 150 miles of cable, 76 studios, four performance spaces, and a library with more than two million pieces of music. "We could duplicate radio easily--but people are tired of it and aren't going to pay $10 a month for it," says Maria Carchidi, Sirius' VP of music programming.

For a supposedly tired medium, radio is remarkably popular. But at least some music lovers say it leaves a lot to be desired. "Radio programming is at an all-time low," says Matt Feinberg at Zenith Media. "It's more generic than ever all over the country." Music outside the mainstream, like gospel and New Age, doesn't get airtime. Some 20% of music sold on CDs, tapes, or records falls into a format that isn't available on commercial radio, according to Margolese. Try finding a classical music station if you're driving through, say, Detroit. And then there are those ads. The typical FM station now has around 15 minutes of advertising every hour--which sounds like a pretty plausible explanation for road rage.

Sirius is betting that its nationwide reach will allow it to provide the specialized programming that local stations can't. Add up all America's classical junkies, for instance, and you may collect enough listeners for not one but three classical channels--symphonic, chamber music, and classical voices. The same math suggests that there's enough demand for five country channels, ranging from bluegrass to alternative, three jazz channels, five Latin channels, and even a sock-hop oldies channel.

A Sirius station won't be an endless stream of music but rather a show (including live performances from Sirius' studios) put together by a programmer who knows a genre inside and out. Sirius' staff of 30 veterans runs the gamut from Don Kaye, the hard-rock guy who wears spiked white-blond hair, lots of metal, and a funky silvery-blue shirt, to Broadway impresario Mike Peters, a gray-haired gentleman in a suit. Sting, in addition to serving as creative consultant, will host a daily show. MC Lyte and Grandmaster Flash will host their own channels.

Sirius isn't just about the music. The 50 other channels, overseen by Elana Sofko, a former senior manager at News Corp., will offer news and information provided by third parties. One of the first to sign on was NPR, which announced in 1999 that it would program two Sirius channels. "Sirius is a new form of distribution. We must be there. We feel it's imperative," says NPR CEO Kevin Klose. Sirius has deals with other big-name content providers too, including A&E, Discovery, CNBC, and the BBC. One of its sports channels will be devoted to major-league baseball; Sandra Bernhard will host a weekly live show from Sirius on the comedy channel. Sofko says everyone is calling, from the intriguing (Tina Brown) to the absurd (a podiatrist who wants to do a show on foot fungus).

Sirius was supposed to be rocking by now. Outsiders blame the delay on the later-than-expected launch of its satellites and the chip set for its radios, which still isn't ready. Margolese, who is talking about a slow rollout to ensure that all the systems work flawlessly, with a major retail push planned for mid- to late 2001, says that schedule wouldn't change even if the chip set were ready. But as David Kestenbaum, an analyst at ING Barings, says, "it's good to be very safe and slow, but the markets are impatient."

Perhaps more disturbing for Sirius, the delays have given rival XM a chance to catch up. On Jan. 8, XM's first satellite, Roll, is scheduled to take flight from Sea Launch, a converted oil rig near the equator that's a Boeing joint venture. Rock, XM's other bird, is scheduled to launch in early March. XM, which developed its chip set in-house (a source of great pride for CEO Hugh Panero), recently rolled out a complete set of radios at the Consumer Electronics Show. Panero is planning to unleash a $100 million advertising campaign this summer, when XM radios should be available in 2002 Cadillacs.

Panero, 44, has proved he can get things done. XM's original backers (including American Mobile, then owned by Hughes and McCaw Cellular), anted up $89 million for a license in 1997. Not a lot more happened until June 1998, when Panero, who had helped build Time Warner's cable system in New York, arrived. "There was a name, a license, technology, and a CFO," says Panero. Within 20 months he raised $1.3 billion from investors including General Motors, Clear Channel, DirecTV, and the public markets. Ron Zarrella, the president of GM North America, and Randall Mays, the CFO of Clear Channel, are on XM's board.

Panero is as casual as Margolese is cerebral. He's got his feet up on his desk, and is dressed in khakis and an open-necked black shirt, with his graying brown hair swept back from his face. "It was dark brown a year ago," he says. A self-described "TV nut," Panero has filled his office with personal artifacts, including a photo of construction workers perched on a sky-high girder ("You're always on the ledge"), a black-and-white photo of a pair of hands ("Work hard"), and a plastic Darth Vader (no explanation needed). He scoffs at the idea that a Manhattan location is important. "AOL is in Dulles, and BET is a mile from here. The idea that you need to be in Rockefeller Center is almost ludicrous."

XM's four-month-old headquarters at 1500 Eckington Place, in a decidedly unglamorous section of D.C., costs just $14 a square foot, less than one-quarter the standard rent in Midtown Manhattan. The three-story building, formerly the headquarters of a commercial printing firm, was abandoned (save for pigeons) until XM moved in. Now XM's 180 new employees buzz around the loftlike space, and construction of XM's 82 music studios--including one that will hold a 30-piece orchestra--is under way.

The difference between Sirius and XM is more than superficial. Start with the technology. Sirius' three satellites travel in elliptical orbits 23,000 miles above the earth, while XM's pair of more powerful geostationary satellites will sit 22,300 miles up. Sirius will use a small network of 100 ground repeaters to amplify the signal in places where tall buildings or tunnels could interfere. XM will use around 1,700 repeaters. It's hard to say whether there will be a noticeable difference in sound quality. "We're better," insists XM engineering chief Jack Wormington, a former Air Force brigadier general who ran Cape Canaveral. "I'm not going to get into it," says Margolese.

Even if the technology is more or less equivalent, XM and Sirius are still different beasts. For one thing, XM will have advertising, albeit a limited amount, on its music channels. For another, XM will get some of its programming from traditional radio, including Clear Channel, Hispanic Broadcasting, and Salem Communications, the largest broadcaster of religious and family content.

The terrestrial folk say that their collaboration with XM is a low-risk way to keep an eye on satellite radio. "I don't think anyone has a crystal ball, but we expect some degree of success," says Ed Atsinger, the CEO of Salem. "After all, in the '60s people didn't take FM seriously." Clear Channel declines to comment, saying only that "XM is a good long-term investment." "Clear Channel is covering its bases," says Robert Peck, an analyst at Lehman. Panero points out that ABC embraced cable and launched ESPN, while CBS ignored the burgeoning industry--with almost fatal results.

Even so, XMers are no more complimentary to terrestrial radio than are the Sirius people. XM's 40 or so channels of original programming are overseen by Lee Abrams, who in FM's early days pioneered the now ubiquitous "classic rock" format. "We're out to revolutionize the sound of radio," says Abrams, whose office walls are covered with gold records given to him by grateful bands, from U2 to Iron Maiden. "Great TV commercials are doing a better job with sound than radio is."

Abrams' plans revolve around passionate deejays with big personalities. "Authenticity" is a favorite word. "Blues won't be watered down for white suburban kids who just bought their first Eric Clapton," he says. Eddie Webb, the metal guru, who's wearing a Monsters of Rock T-shirt, adds, "In traditional radio, advertisers become the programmers. We'll say the F-word and be true to it. It's going to be in your face." XM's promo material promises that Sirius will sound "canned" by comparison.

Nor does XM intend to be confined to your car. XM wants to be in your home, on the plane, and at the beach. One clue to the future is a four-by-five-inch Sony XM radio. It'll slide into a docking station in your car stereo or in your home. There may even be a package deal with DirecTV in the works.

If Sirius, XM, and their backers are right, then radio is on the verge of its second Golden Age. But skeptics point out that in the early 1990s, subscription digital radio over cable into the home was the hot idea. Lon Troxel, the CEO of DMX, one of two remaining companies, says that penetration rates fell short of expectations. Now DMX is bundled in with digital cable, and Troxel cites research showing that around 75% of homes listen to it for an average of eight hours a week. In other words, the problem wasn't the product but the payment.

There's also lots more competition now, including Internet radio. For instance, a startup called Sonicbox has created what it calls the iM band--800 "best of planet" channels, ranging from Nashville acoustic blues to Scottish chanting. Listeners can even add MP3 downloads. Sonicbox CEO Scott Smith says that in three years wireless broadband will enable a car crossing the country to receive Sonicbox broadcasts. "I would not be building a subscriber model today," he says.

Most important, satellite radio's new best friends--the car companies--may not live up to expectations. Satellite radio becomes a much easier sell if it's embedded in the cost of a new car along with the leather interior, air bags, and floor mats. Sirius trumpets its deals with BMW, Ford, and DaimlerChrysler, while XM announced its GM agreement with great fanfare. But details remain scarce. "The success of this is predicated on how hard the car manufacturers push," says Vijay Jayant, an analyst at Morgan Stanley. "And we don't know what they've really committed to."

Nor will the auto manufacturers necessarily act in unison. GM says that it plans to rapidly deploy XM across all its lines. Ford's director of telematics, Russ Minick, notes that with services like GPS on the rise, consumers could be overwhelmed. "It's hard for us to jump onboard quickly," he says. "We don't want to overload the consumer." Minick emphasizes that nothing has been decided yet, but says that Ford is planning on a pilot program in late 2001 and then on offering Sirius in its 2003 model-year SUVs and Lincolns.

All of this can be sorted out--eventually. But even with optimistic projections, Sirius and XM are nowhere near done consuming cash. Analysts estimate that Sirius needs to raise another $450 million, while XM needs some $500 million. If technological delays or slower-than-expected consumer acceptance adds to those estimates, it's an open question whether investors--even current backers--will cough up more money.

To date, almost no outsiders have heard satellite radio live in a car. One who has is Ford's Minick, who flipped between FM stations and Sirius during a test drive. "The difference is really impressive," he raves. "It's pretty hard to beat." That's music to Sirius' ears.