Sirius Case Part 1

1. Sirius Satellite Radio, Incorporated provides satellite radio in the United States. They offer 133 channels-69 channels of 100% commercial-free music and 64 channels of sports, news, talk, entertainment, traffic, weather, and data content to their subscribers. When comparing Sirius Satellite Radio to that of traditional AM/FM broadcast radio stations, they have many competitive advantages. Some of these competitive advantages include broadcast reception paid for by subscription fees rather than commercial advertising, making them commercial free, an extensive range of specialized channels, third-party content such as Howard Stern, NFL, and NASCAR, and the offering of multiple platforms available for subscribers to listen to their channels such as over the Internet, DISH satellite television, multimedia handsets, and car radio, for example.

2. Two key risks that are associated with Sirius Satellite Radio’s business model relative to traditional broadcast radio stations are their inability to supply users with local content such as local news and sports and their ability to sustain subscribers while attracting new ones. The traditional broadcast radio does not face these risks because they are able to provide a much wider range of specialized local content. They also do not encounter issues with continuing subscribers or their ability to generate new ones because their services are free.

3. Sirius’ business is dependent, in part, upon the efforts of third parties. One of the third parties includes automakers that manufacture, market and sell vehicles capable of receiving their service. Sirius’ ability to generate and sustain competitive advantage through this distribution channel is not strong because the automakers that manufacture, market and sell vehicles capable of receiving their services have no obligation to do so. The automakers are very powerful and do not have room to risk negotiating the price of contracts between these automakers because they could easily lose them to their competitors who may offer a more appealing price. The automakers have the power in these agreements leaving Sirius little to no potential to sustain competitive advantage.

4. Sirius currently accounts for their subscriber acquisition costs, as described in their 2005 10-K report, generally by incurring and expensing them in advance of acquiring a subscriber and are then recognized as subscriber acquisition costs. These costs include hardware subsidies paid to radio manufacturers, distributors, and automakers, including subsidies paid to automakers who include a Sirius radio and a prepaid subscription to their service in the sale or lease price of a new vehicle; subsidies paid to chip set manufacturers; and commissions paid to retailers and automakers as incentives to purchase, install and activate Sirius radios. Subsidies paid to radio manufacturers and automakers are expensed when shipped or installed. The commissions paid to retailers and automakers are expensed either when active or at the sale of the Sirius radio. The chip sets that are sent to the radio manufacturers and then held on consignment are recorded as inventory and expensed as subscriber acquisition costs when entered into the production cycle. The chips that are not held on consignment are instead expensed as subscriber acquisition costs upon shipment to radio manufacturers.

5. Assuming that instead of using Sirius’ current accounting practices for their subscriber acquisition costs they capitalized all of their subscriber acquisition costs in the fiscal year that these costs are incurred and then amortizes them using the straight-line method over the subsequent two fiscal years, their estimated loss from operations that they would have reported for the fiscal year ending December 31, 2005 would have been a loss of $570,645.50. I calculated this loss by adding subscriber acquisition costs in 2005 which were $399,350 (349,641+49,709) to the reported loss from operations for 2005 which was $829,140. Then using the assumption that these costs are incurred and then amortized using the straight-line method over the subsequent two years, I subtracted half of the subscriber acquisition costs in 2004 $103,425.50(86,851+16,574.50) and then subtracted half of the subscriber acquisition costs in 2003, $37,430.

6. The accounting method for subscriber acquisition costs that better reflects the underlying economics of the business would be capitalizing the costs and then amortizing them over the next two years. Sirius states in their 10-K that they use various key metrics to monitor their operating performance which includes an average monthly churn percentage for 2005-2003 which represents the average of the number of deactivated subscribers divided by average quarterly subscribers. The average monthly churn rate for these three years is 1.53%. Customers do not deactivate their subscriptions very often. This shows that subscribers are holding their memberships for multiple years and amortizing the costs over two years or more would be more plausible.

7. Sirius accounts for subscriber revenues, which are services provided to a subscriber, by recording deferred revenue for prepaid subscription fees and then amortizing those prepayments to revenue ratably over the term of the respective subscription plan.

8. Assuming that instead of Sirius’ current accounting practices for subscriber revenue they recognize subscriber revenue upon the receipt of subscriber payments, their estimated loss from operations that they would have reported for the year ending December 31, 2005 would have been a loss of $618,193. I calculated this loss from operations by instead of deferring 2005’s revenue, including it in the current year. The deferred revenue for 2005 was shown on the statement of cash flows in Sirius’ 10-K report for $210,947. I then added that to the loss of $829,140 and arrived at a loss of $618,193.

9. Sirius accounts for their FCC license by treating it as an indefinite-lived intangible asset, goodwill and other intangible assets, due to its renewable eight-year term with the expectation to renew it upon completion of the eight years. Each reporting period Sirius re-evaluates the useful life of the license to support its indefinite useful life. They test the FCC license for impairment at least annually, using the direct approach in estimating the fair value. To date, they have not recorded any amortization expense or impairment related to the license. I believe that Sirius’ application of this current accounting method for their FCC license is a slightly aggressive approach considering their trend of continually generating losses. I think they should take a more conservative approach in order to be safe and record impairment.

10. The computation for property, plant, and equipment turnover ratios for Sirius and Citadel Broadcasting Corporation for fiscal year 2005 can be viewed on the second to last tab of the attached excel workbook labeled “Question 10”. Sirius’ property, plant, and equipment turnover ratio for 2005 is .283 while Citadel’s is 4.668.

11. The major reason for the differences between the two turnover ratios provided in question 10 is mainly due to the difference in property plant and equipment compared to that of the other company. Sirius has over $700,000 more property plant and equipment than Citadel has for both 2004 and 2005. Even though Citadel has a significantly smaller amount of property plant and equipment, they have higher sales than Sirius by approximately $200,000. The large difference in property plant and equipment is because of Sirius’ satellite systems that Citadel does not use. Citadel does not need as much assets, let alone the satellite systems, because they provide a basic type of radio broadcasting service to certain areas, mentioned in their 10-K.

12. The computation for the operating margin for 2005 for both Sirius and Citadel Broadcasting Corporation can be viewed on the last tab of the attached excel workbook labeled “Question 12”. I calculated Sirius’ operating margin ratio for 2005 to be -342.27% and Citadel’s to be 34.15%.

13. The main reasons behind the large differences in the operating margins computed above for both Sirius and Citadel are due to Sirius’ large negative operating income. This large difference in income is because of how much more Sirius spends on sales and marketing compared to Citadel and their investment in the satellite systems, which Citadel does not have. Sirius is still relatively new and has not yet experienced an adequate amount of earnings to account for their large investment in the satellite systems and their large and increasing sales and marketing expenses.

14. Sirius’ net loss has been more negative than their free cash flow for fiscal years 2003, 2004, and 2005 for a number of reasons. One reason is because of how they account for their subscriber revenue. By deferring these costs until they provide their services, revenue is understated on the income statement but not in free cash flow. Another reason is because of their large depreciation expense for their satellite system which is not included in free cash flow. Another reason behind this difference is their accounts payable, accrued expenses, and equity granted to third parties and employees.