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XM Satellite Radio and Sirius Satellite Radio
Some investors are just like little kids: They love a good story, and the more outrageous the tale the better.
But investing is not like fairy tales; happily ever after is not a foregone conclusion.
So when investors buy a stock based on its story more than its financial underpinnings, they need to make sure they are not falling for tall tales.
Two of the tallest tales in investing right now amount to the entire field of competition for one business, and while the industry has tremendous potential, that rosy future is not enough to keep XM Satellite Radio and Sirius Satellite Radio from being the Stupid Investment of the Week.
Stupid Investment of the Week showcases the trouble spots and danger zones that make an investment less-than-ideal for the average consumer, in the hope that highlighting problems in one issue (or sometimes two), will make them easier to root out elsewhere. While obviously not a purchase recommendation, neither is this column intended as an automatic sell signal, as there may be times when unloading a worrisome investment simply compounds the problem.
In the case of XM and Sirius, that problem could be huge capital gains for shareholders who bought in early, rode a rocket through 2003 and 2004, and who have held on through the steep declines the companies suffered from last year into 2006.
It is that downturn, however, that has nonshareholders thinking the satellite radio companies could be a buy, beaten down sufficiently to where they are a good deal. The story spurring most of these would-be bulls for the stocks is that having gone through an explosive growth phase, they are having a temporary "correction," a breather before the next sprint toward cashing in on the enormous potential of the business.
Here's where average investors should recognize a language problem. "Correction" is a technical term for a market reversal of more than 10 percent. In human terms, however, something that is wrong is what gets corrected, and the wrong that the market is currently correcting for XM and Sirius is overblown market value.
That problem won't be corrected for either stock until there's been a lot more pain.
More backsliding is hard to believe for two stocks off about 40 percent from their 52-week high and in a business with so much potential, so let's examine the plusses and minuses for XM and Sirus.
Both stocks have seen the kind of triple-digit gains in the past that speculative investors dream about.
Moreover, satellite radio is a business that average investors feel like they understand, especially if they try the service and like it.
But tremendous growth is only an asset if a stock has the financial fundamentals to make it turn out right. Consider the report card that Morningstar gives both stocks: they each get an A for growth (Sirius gets an A+), an F for profitability and a D- for financial health.
If your kids brought home that report card — especially when growth is the financial equivalent of an exercise class and the other marks are the heavy lifting — you'd ground them for months.
The two satellite radio providers appear to be locked in mortal combat, living under "the prophecy" that guides the hero and villain of the Harry Potter books. That prophecy states that "neither can live while the other survives."
That means a buy-and-hold investor bent on capturing the potential of the industry is taking a gamble that easily could wind up being vanquished in the end.
And while analysts seem to be giving XM the hero's position right now, it's almost a coin flip (as those similar Morningstar grades show).
"The kind of expenditures required to get programming and develop the infrastructure and get the subscribers is extraordinary, and they have been putting everything into it and they're still losing money," says Rudolph Martin, director of research for Weiss Ratings, which has a sell advisory on both stocks. "They're still losing big money, and you can't expect a 180-degree turnaround.
"We'll play a story stock, but only if the fundamentals support doing it."
Both Sirius and XM have bloated price-to-sales ratios, and have monster debt that includes significant slugs that can be converted to common stock.
That means that if the stocks ever do rebound, those debt holders stand ready to cash in and significantly dilute the value of current common shareholders. (Conversely, if the stocks were ever to wind up in bankruptcy, the debt holders would have seniority over those same shareholders; kind of makes the average shareholder wish they had those bonds instead.)
Trying to come up with a fair-value estimate on the stocks is hard, but it seems to be in the $2 range for Sirius and the $20 range for XM. If they get beaten down to those levels, some growth-oriented investors might declare them a buy, but the average investor wants to get in at a bit of a discount and then have the stock rise up to fair value or beyond.
That means that investors who like this story will need to see the stocks endure more pain before the satellite business looks like a buy again.
Says Robert Green of Briefing.com: "The potential is grossly overpriced into both of these stocks; they are overvalued and the best you could forecast for them over the next few years is that they might somehow grow into their current valuations. That's not a good situation for investors, no matter how much they love what the companies stand for."
Chuck Jaffe is senior columnist for MarketWatch. If you have a suggestion for Chuck Jaffe's Stupid Investment of the Week or a comment about this week's column, you can reach him at jaffe@marketwatch or Box 70, Cohasset, MA 02025-0070.
Copyright 2006, MarketWatch