Xm satellite Radio Inc. The Story of a Startup

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XM Satellite Radio Inc.
The Story of a Startup
Information on the following pages is taken from the 10-K filing of XM Satellite Radio, Inc. See the last page of the case for a set of questions you should answer in your analysis of the case.

Except for any historical information, the matters we discuss in this Form

10-K contain forward-looking statements. Any statements in this Form 10-K that

are not statements of historical fact, are intended to be, and are, "forward-

looking statements" under the safe harbor provided by Section 27(a) of the

Securities Act of 1933. Without limitation, the words "anticipates,"

"believes," "estimates," "expects," "intends," "plans" and similar expressions

are intended to identify forward-looking statements. The important factors we

discuss below and under the caption "Management's Discussion and Analysis of

Financial Condition and Results of Operations," as well as other factors

identified in our filings with the SEC and those presented elsewhere by its

management from time to time, could cause actual results to differ materially

from those indicated by the forward-looking statements made in this Form 10-K.
This annual report is filed jointly by XM Satellite Radio Holdings Inc.

("Holdings") and XM Satellite Radio Inc. ("XM"). XM is a wholly-owned

subsidiary of Holdings. Unless the context requires otherwise, the terms "we,"

"our" and "us" refer to Holdings and its subsidiaries. This report on Form 10-K

contains separate financial statements for each of Holdings and XM. The

management's discussion and analysis section has been combined, focusing on the

financial condition and results of operations of Holdings but including an

explanation of any differences between the companies.

We seek to become a premier nationwide provider of audio entertainment and

information programming. We will transmit our XM Radio service by satellites to

vehicle, home and portable radios. We own one of two FCC licenses to provide a

satellite digital radio service in the United States. We will offer a wide

variety of music, news, talk, sports and other specialty programming on up to

100 distinct channels. We believe that customers will be attracted to our

service because of its wide variety of formats, digital quality sound and

coast-to-coast coverage.

We are preparing to launch our satellites and have contracts with third

party programmers, vendors and other partners. Key milestones achieved include

the following:
. $1.3 billion of equity and debt net proceeds raised to date; we are

funded through our planned commencement of commercial operations in the

summer of 2001 and into 2002; our strategic and financial investors

include General Motors, Clear Channel Communications, DIRECTV, Telcom

Ventures, Columbia Capital, Madison Dearborn Partners, American Honda and

AEA Investors;

. Long-term agreement with the OnStar division of General Motors covering

the installation and exclusive marketing and distribution of XM Radio

service in General Motors vehicles; Agreement with Freightliner

Corporation to install XM radios in Freightliner trucks;

. Boeing Satellite Systems completed construction of two high-powered

satellites ("Rock" and "Roll") which are scheduled to be launched in

March and May of this year;
. Opening of our new headquarters and Broadcast Center in Washington, D.C.

featuring over 80 interconnected all-digital studios;

. Contracts with Delphi-Delco Electronics, Sony, Motorola, Pioneer, Alpine,

Mitsubishi, Audiovox, Clarion, SHARP, Blaupunkt, Fujitsu Ten, Hyundai

Autonet, Bontec, Visteon, Panasonic and Sanyo to manufacture and

distribute XM radios;

. Completion of our production chipset design and commencement by ST

Microelectronics, our chipset manufacturer, of fabrication to make the

components available to radio manufacturers starting the end of March

. At the Consumer Electronics Show (CES) in January 2001, six

manufacturers, including Pioneer, Alpine, and Sony, unveiled 24 different

models of XM-ready radios, we won the "Best of CES" award for the

automotive category and the XM Sony "plug and play" device won the "CES

Innovation 2001 Award" and the Popular Mechanics "Top 15 CES Products

. Circuit City, Best Buy, Radio Shack, Sears & Roebuck Co., Tweeter,

Ultimate, Al and Ed's, CarToys, Sound Advice, Mobile-One, Crutchfield,

Cowboy Maloney's Electronic City and Magnolia Hi-Fi have announced that

they intend to distribute and promote XM Radio products and services; and

. Agreements with leading specialty programmers, for many of which we will

be the exclusive satellite radio platform, covering at least 25 channels,

including AsiaOne, Associated Press, Black Entertainment Television

(BET), BBC World Service, Bloomberg News Radio, Clear Channel, CNBC, CNN

en Espanol, CNNfn, CNN Sports Illustrated, Country Music Hall of Fame, C-

SPAN, DIRECTV, Discovery, Firesign Theatre, Hispanic Broadcasting

Corporation (formerly Heftel), NASCAR, One-on-One Sports, Radio One,

Salem Communications, Sesame Workshop, Sporting News, Weather Channel and

USA Today.
Market Opportunity
We believe that there is a significant market for our satellite radio

service. Market studies show strong demand for radio service, as evidenced by

radio listening trends, data relating to sales and distribution of radios and

the general growth in radio advertising. In addition, we note that in many

markets audio programming choices are limited to mass appeal formats. We

believe our national subscription service will complement traditional local

radio. Moreover, the success of subscription entertainment services in other

media such as cable television and satellite television further indicate

potential for significant consumer demand for satellite radio services.
Radio Listening
On average, adults listen to the radio 3.1 hours a day, with the amount of

radio listening fairly evenly distributed across gender and age groups. The

percentage of people listening to radio is also high. Market data show that

over 75% of the entire United States population age 12 and older listen to the

radio daily, and over 95% listen on a weekly basis (Radio Marketing Guide and

Factbook for Advertisers, Radio Advertising Bureau, 2000-2001).

In addition, more people listen to radio than to other comparable audio

entertainment formats. The popularity of radio versus these other formats

appears particularly strong in the car, where we will be targeting our service

initially. An estimated 69% of consumers chose radio as their most listened to

format in the car as compared to 15% for cassettes and 9% for CDs (Radio

Listening Habits, CEMA 1999).

Radio Sales and Distribution
A large number of radios are sold in the United States on an annual basis.

In 1999, radio manufacturers sold over 29 million car radios, including 17

million original equipment automobile radios and 11 million aftermarket

automobile radios, as well as 1.2 million aftermarket automobile CD changers.

Original equipment radios are installed in new cars; aftermarket radios are

installed in the automobile after purchase. Based on these statistics, each

additional one million subscribers would represent less than 3.5% of the new

original equipment manufacturer and aftermarket car radios brought to market

annually and would generate incremental subscription revenues, at $9.95 per

month, of approximately $120 million.

Radio Advertising
The continued popularity of radio is also reflected in the growth of radio

advertising. The Radio Advertising Bureau estimates that radio advertising

revenue in 2000 climbed to $19 billion, an increase of 12% over 1999. Veronis,

Suhler & Associates projects a compound annual increase of 9.5% through 2004.

This growth rate exceeds the projected increase in advertising spending for

television, newspapers, magazines, yellow pages and outdoor advertising

(Communications Industry Forecast, 2000).
Current Limitations on Programming Choice
Many consumers have access to a limited number of stations and programming

formats offered by traditional AM/FM radio. Our service is expected to be

attractive to underserved radio listeners who want expanded radio choices.
Limited Number of Radio Stations. The number of radio stations available to

many consumers in their local market is limited in comparison to the up to 100

channels we expect to offer on a nationwide basis. In 2000, there were only 47

AM/FM radio stations as listed by Arbitron broadcasting in New York City, the

largest radio market in the United States. In fact, many metropolitan areas

outside the largest 50 markets, such as Jacksonville, FL, Louisville, KY, and

Oklahoma City, OK, have 30 or fewer AM/FM radio stations as listed by Arbitron

(American Radio, Spring 2000 Ratings Report, Duncan's American Radio, 2000).

We estimate that our coast-to-coast service will reach over 98 million

listeners age 12 and over who are beyond the range of the largest 50 markets as

measured by Arbitron. Of these listeners, 36 million live beyond the largest

276 markets (Census data and Fall 1999 Market Rankings, The Arbitron Company).

In addition, there are 22 million people age 12 and above who receive five or

fewer stations (The Satellite Report 1999, C. E. Unterberg, Towbin).

Limited Programming Formats. We believe that there is significant demand for

a satellite radio service that expands the current programming choices

available to these potential listeners. Over 49% of all commercial radio

stations use one of only three general programming formats--country, adult

contemporary and news/talk/sports (Veronis, Suhler & Associates Communications

Industry Forecast 2000). Over 71% of all commercial radio stations use one of

only five general formats--the same three, plus oldies and religion. The small

number of available programming choices means that artists representing niche

music formats likely receive little or no airtime in many markets. Radio

stations prefer featuring artists they believe appeal to the broadest market.

However, according to the Recording Industry Association of America, recorded

music sales of niche music formats such as classical, jazz, movie and Broadway

soundtracks, new age, children's programming and others comprised up to 21% of

total recorded music sales in 1998 (1998 Consumer Profile).

Demand for Subscription Services and Products
Penetration data relating to cable, satellite television, and premium movie

channels suggest that consumers are willing to pay for services that

dramatically expand programming choice or enhance quality. As of 1999, over 67%

of TV households subscribe to basic cable television at an average monthly cost

of $29, and over 11% of TV households subscribe to satellite television at an

average monthly cost of $51 (National Cable Television Association website and

DBSdish.com website). Also in 1999, according to Paul Kagan Associates,

subscribers to cable and satellite services purchased more than 75 million

premium channel units, such as HBO, Showtime and Cinemax, for which they paid

an extra monthly charge on top of the basic monthly fee.

Demand for Satellite Radio Services
Several studies have been conducted demonstrating the demand for satellite

radio service.

In June 1999, we commissioned Strategic Marketing And Research Techniques

(SMART), a leading market research company and Dr. Frank M. Bass, a leading

authority on the diffusion of new products and inventor of the Bass curve, to

estimate the demand for satellite radio based on survey data and historical

information. SMART surveyed 1,800 people ages 16 and over. The study concluded

that as many as 49 million people may subscribe to satellite radio by 2012,

assuming a $9.95 monthly subscription fee and a radio price point of $150-$399

depending upon the type of car or home unit chosen. The study also anticipates

that satellite radio will grow even faster than DBS.
In December 1998, we commissioned SMART to conduct a study based on one-on-

one interviews with over 1,000 licensed drivers ages 16 to 64 in ten

geographically dispersed markets. The study concluded that approximately 50% of

aftermarket radio purchases would be for AM/FM/satellite radio units with a

single-disc CD player. This assumed a radio price point of $399, a $75

installation fee and a $10 monthly subscription fee for the service. The same

study also found that consumers are more likely to buy satellite radio units

that offer at least 80 channels.

In November 1998, we commissioned Yankelovich Partners to gauge consumer

interest in satellite radio. This involved surveying 1,000 people via telephone

and correlating the results with the Yankelovich MONITOR study, which is the

longest standing tracking study of consumer values and attitudes in the United

States. The study indicated that 18% of people age 16 and older were

"definitely" or "probably" willing to pay $9.99 per month to receive satellite

radio and an additional $150 for a satellite radio when buying a new car.
The XM Radio Service
We are designing the XM Radio service to address the tastes of each of our

targeted market segments through a combination of niche and broad appeal

programming. We believe that our distinctive approach to programming, combined

with digital quality sound and virtually seamless signal coverage throughout

the continental United States, will position us to become the leading provider

of the next generation in radio.

We Will Differentiate XM Radio from Traditional AM/FM Radio
Local radio stations, even those which are part of national networks, focus

on maximizing listener share within local markets. This limits the types of

programming they can profitably provide to mass appeal formats. In contrast,

our nationwide reach and ability to provide up to 100 channels in each radio

market will allow us to aggregate listeners from markets across the country,

expanding the types of programming we can provide. The following chart

indicates differences between XM Radio and traditional AM/FM radio.

XM Radio Traditional AM/FM Radio

---------------------------- -------------------------------

Convenience: go anywhere Virtually seamless signal Local area coverage

capability coverage in the United


Choice: wide variety/number Up to 100 channels with a Limited formats in many markets

of stations wide variety of programming

Improved audio quality Digital quality sound Analog AM/FM quality sound

Fewer commercials Average 6-7 minutes per Average 13-17 minutes per hour

hour; some channels

commercial free

More information about music Text display with title/name No visual display

of song/artist
We plan to further differentiate XM Radio from traditional AM/FM radio in

the following ways.

Provide music formats unavailable in many markets. XM Radio will offer many

music formats that are popular but currently unavailable in many markets. More

than 49% of all commercial radio stations in markets measured by Arbitron use

one of only three programming formats: country; adult contemporary; or

news/talk/sports. There are many types of music with significant popularity, as

measured by recorded music sales and concert revenues, that are unavailable in

many traditional AM/FM radio markets. Such music could include classical

recordings or popular blues and rap music that have retail appeal but are not

commonly played on traditional AM/FM radio. This music also includes special

recordings such as the Irish dance soundtrack "Riverdance" and the "Three

Tenors" concerts which generate millions of CD sales, yet are not typically

played on today's AM/FM stations. Additionally, heavy metal and dance are two

of the more popular musical styles not currently broadcast in many small and

medium sized markets. Even major markets do not always offer a full complement

of formats.
Superserve popular music formats. We will be able to offer more specific

programming choices than traditional AM/FM radio generally offers for even the

most popular listening formats. For example, on traditional AM/FM radio oldies

music is often generalized on a single format. We will be able to segment this

category by offering several dedicated, era-specific formats. We also plan to

offer up to six dedicated channels with urban formats and four distinct country

music formats.
Use more extensive playlists. Traditional AM/FM radio stations frequently

use limited playlists that focus on artists and specific music that target the

largest audience. With our large channel capacity and focus on specific

formats, we have the ability to provide more variety to attract listeners

dissatisfied with repetitive and/or limited playlist selection offered by

traditional radio.

Deliver a wide range of ethnic and informational programming. We will

provide a variety of formats that target specific ethnic and special interest

groups who are rarely served by traditional AM/FM radio. We believe by using our national platform to aggregate geographically disparate groups through affinity programming, we will provide advertisers a valuable way to market products and services to these groups by advertising on our affinity channels.
Develop promotional opportunities with record companies, recording artists

and radio personalities. Because of our nationwide coverage and resulting

economies of scale, we will be able to deliver a variety of national promotions

and events that would not be cost effective or efficient on a market-by-market

basis through traditional AM/FM radio distribution. Also, we will seek to hire

and develop high profile talk and disc jockey talent capable of becoming the

next generation of national radio stars with an influence on radio similar to

the impact that the new breed of cable TV talk hosts have had on the television

Respond quickly when major music and cultural events occur. XM Radio

programmers will respond quickly to changing musical tastes, seasonal music and

emerging popular cultural events, such as Bruce Springsteen and Ricky Martin

tours, by providing listeners with extensive coverage utilizing our large

channel capacity.
Take advantage of digital's higher quality signal. There are several music

formats that have strong demand but have been relegated to AM stations with

weaker signals due to lack of available FM frequencies. Such AM formats include

traditional country music, big band/nostalgia and gospel formats that we will

be able to deliver with superior sound quality.
Focus on special demands of mobile listeners. A significant percentage of

radio listeners, such as truckers, routinely travel through two or more radio

markets on a frequent basis. According to the U.S. Department of

Transportation, there were over three million truckers in the United States in

1997. We believe these listeners will be attracted to a radio service with

national coast-to-coast coverage. We are seeking to specifically identify and

target the listening demands of this audience.
Availability of commercial-free and limited-advertising channels. We believe

that a significant portion of the listening market would pay to subscribe to a

radio service that provided commercial-free channels and channels with reduced

advertising, as demonstrated by the appeal of limited periods of non-stop music

used by some traditional AM/FM stations. Therefore, we plan to target this

audience with a number of commercial-free music channels covering popular music

formats. In addition, we expect that our limited-advertising channels will

carry less than half the advertising spots of typical AM/FM stations.

Use cross-promotion capability to market XM Radio. We will dedicate a

percentage of our advertising inventory across our channels to promote specific

programming and brand loyalty. AM/FM radio stations traditionally promote on a

single channel basis to build awareness.

Representative XM Radio Channel List
The following table is a list of representative channels we may offer.

Channels in italics represent contractual commitments with content providers.

Representative Channels of XM Radio

---------- ----------- --------

Classic Rock All News (USA Today) Tejano (Hispanic Broadcasting

Classic Hard Rock All News (Bloomberg) Corp.)

New Hard Rock Public Affairs (C-SPAN) Caribbean (Hispanic Broadcasting

New Alternative Financial News (CNN fn) Corp.)

Classic Alternative News/Information (BBC World Regional Mexican (Hispanic

Soft Rock Service) Broadcasting Corp.)

ECLECTIC MUSIC Travel, Home, Science, Animals Rock en Espanol (Hispanic

-------------- (Discovery) Broadcasting Corp.)

Contemporary Christian Love/Relationship Line Hispanic Ballads (Hispanic

(Salem) Farm/Rural Broadcasting Corp.)

Traditional Christian Health/Fitness Hispanic News (CNN en Espanol)

(Salem) Comedy OLDIES MUSIC

Blues Audio Book ------------

Traditional Jazz 40's Oldies

Reggae/Island 50's Oldies

World Music 60's Oldies

American Folk Consumer Classified 70's Oldies

Pop Classical Soap Operas 80's Oldies

Traditional Classical For Truckers Only 90's Oldies

Modern Jazz Movie Soundtrack Channel Love Songs

Progressive/Fusion Lifestyles TALK

POP MUSIC Celebrity Gossip ----

--------- Entertainment News African American Talk

Top 20 Contemporary Hits Game Show/Contest (BET/Radio One)

Disco/Dance URBAN MUSIC Asian/Indian Talk (AsiaOne)

Broadway Show Tunes ----------- Christian/Family Talk (Salem)

Modern Adult Contemporary Hip Hop/Rap (BET/Radio One) Mandarin Talk (AsiaOne)

Classic Vocalists Urban Dance Mix (Radio One) Conservative Talk

All Request Contemporary Classic Soul (BET/Radio One) Liberal Talk

Hits Gospel (BET/Radio One) Senior Citizen Talk

SPORTS Adult Urban (BET/Radio One) Rock Talk

------ Top 20 Urban Hispanic Talk

Sports Headlines ENVIRONMENTAL MUSIC Teen Talk

(CNN/Sports) ------------------- CHILDREN'S MUSIC

Sports Talk (One-On-One Soft Jazz ----------------

Sports, New Age Pre-School

Sporting News) Electronic Grade School/pre-teen

Sportsman Channel Environmental (Earth Sounds) SPECIAL/EVENTS

Automotive (NASCAR) Beautiful Instrumentals --------------

COUNTRY MUSIC Reserved Channels


Mainstream Country

Classic Country



All Request Country

Key Elements of Our Business
We have developed a business strategy to become a premier nationwide

provider of audio entertainment and information programming in the vehicle,

home and portable markets. Our strategy includes the following elements.
We believe that the quality and diversity of our programming will be a key

driver of consumer interest in our service. To that end, we have developed a

unique programming strategy that offers consumers
. Original music and information channels created by XM Originals, our in-

house programming unit;

. Channels created by well-known providers of brand name programming; and
. The availability of commercial-free and advertiser-supported channels.
XM Originals. Through a programming unit in XM Radio called "XM Originals,"

we will create a significant number of original channel formats with content

focusing on popular music such as oldies, rock and country, and on new and

innovative formats, including jazz, blues, reggae and pop classical. These

formats will include artists with strong music sales and concert revenue who do

not get significant airplay on traditional AM/FM radio stations. We also intend

to brand individual channels creating a specific station personality and image

using compelling on-air talent and other techniques to attract listeners in our

target market segments. We have hired a team of programming professionals with

a proven track record of introducing new radio formats and building local and

national listenership.
Brand Name Programming Partners. We intend to complement our original

programming with a variety of unique and diverse content provided to us by

brand name programming providers. We have signed contracts representing at

least 25 channels with numerous well-known specialty and niche programmers that

will provide brand name content for XM Radio. These companies include:

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