Making Waves

By Daren Fonda

Unless you're familiar with New York City's burlesque scene, you may not know about the Glamazons, a troupe of plus-size female dancers who like to camp it up around town. A few weeks ago, however, a handful of Glamazons were featured on a live national radio show, guests of a gay-and-lesbian duo named Derek and Romaine who were celebrating their second anniversary on the air. With a bartender mixing martinis in the studio, the scene was suggestive of radio's party days, before Big Radio ate the AM/FM dial, demanded quarterly profit growth and sucked the fun right out of the control booth. Except that a wannabe big corporate entity was footing the bill for the show, broadcast from a gleaming new studio in a Rockefeller Center skyscraper. And the Glamazons were tame compared with the time Romaine invited a male porn star into the studio for a little on-air fun, and curtains had to be drawn--this for a radio show. "If listeners find it interesting, that's great," said Romaine. "But really the whole show is about us."

Welcome to Sirius Satellite Radio, a company running edgy programming and sparing no expense in its quest to breathe life into radio--and one day turn a profit for shareholders. Based in New York City and run by pugnacious radio-industry veteran and media icon Mel Karmazin, Sirius broadcasts 65 channels of commercial-free music, sliced and diced in formats from Broadway-show tunes to '80s hair bands, along with channels dedicated to sports, news, weather and niche shows like Derek and Romaine's, which would be fined into extinction if the FCC had its way. This being satellite radio, whose subscribers pay a $12.95 monthly fee, the content cops have no say in what's beamed down from Sirius' three satellites. And Sirius is taking full advantage of its outlier status to serve up fare you would never hear over the AM/FM dial, from frat-boy channels like Maxim Radio to hip-hop so crude it might make Eminem blush.

Sirius and its bigger satellite competitor XM are death stars to the broadcast-radio industry. Since 1996 companies such as Clear Channel and Infinity (part of Viacom) have taken advantage of deregulation to buy hundreds of stations with the idea of bringing scale--and higher ad prices--to the airwaves. For a while it worked, as industry revenues rose at a double-digit clip during the late '90s ad boom and stations racked up profits thanks to cost cutting. But for listeners, that consolidation brought homogeneity, as corporate playlists suffocated local jocks, and ever more ads were jammed into each hour.

No wonder that in the past year satellite radio, which like cable TV was once laughed at--pay radio? C'mon--reached critical mass. Sirius' audience surged from 351,600 listeners to more than 1.4 million; XM added 540,000 subscribers in the first quarter of this year to reach an audience of 3.8 million. Reasons: better programming choices; lots of programming choices. In other words: game on. Advances in technology mean that every listener is up for grabs. Broadcasters have to contend not only with satellite operators like Sirius but also with cell-phone makers and service providers, iPods and even Internet amateurs who can find audiences for the oddest musical tastes. Broadcast radio's answer: fighting back with its own digital strategy.

Satellite radio clearly has momentum, but broadcast, or terrestrial, radio still owns most of the market. Local radio may be clogged with ads and promos, banal chatter and the same 200 songs spun ad nauseam, but almost everyone tunes in at some point during the week, according to ratings firm Arbitron. Viacom recently wrote down the value of its Infinity radio business by $10.9 billion, but terrestrial radio still hauls in around $20 billion a year in revenues, mainly from local advertisers like car dealers and banks, rendering it an important marketing tool and generator of free cash flow. Sirius, in contrast, forecasts revenues of just $210 million this year and an operating loss of $480 million. Moreover, the company is continually playing catch-up to XM, which has leapfrogged Sirius with its technology and consumer electronics and boasts its own compelling programming, including dozens of ad-free music channels, Major League Baseball games and, not to be outraunched, shock jocks Opie & Anthony and Playboy Radio (the latter for a premium over the standard $12.95 monthly fee).

What XM lacksand what Sirius is gambling onare marquee names like Howard Stern and Martha Stewart, stars who CEO Karmazin is convinced will differentiate his brand and lure subscribers and, eventually, big ad dollars. Stern, whose history with Karmazin dates to the mid-'80s, fits in naturally with Sirius' bad-boy image. Frustrated by the feds' indecency crackdown, Stern is literally counting down the minutes (on his website) left on his contract with Infinity, his current home. He has been a relentless promoter for Sirius, trying to coax his 12 million listeners over to pay radio. He is also charging Sirius a fortune to air his signature blend of flatulence jokes and advice to strippers on breast implants: $100 million a year for five years, starting in 2006, a deal signed shortly before Karmazin came on board last fall.

If Stern brings in the young dudes, it will be up to Stewart to even the scales with women. Sirius appeals to guys because men tend to be early technology adopters and because Sirius has bulked up on pro sports, offering channels for NBA, NFL and NHL games (assuming that hockey returns), and starting in 2007, stock-car racing via NASCAR, which Karmazin lured from XM. Sirius signed Stewart for a bargain $30 million over four years, plus a share of ad sales. It's paid to her company, Martha Stewart Living OmniMedia, in return for a 24-hour women's lifestyle channel, featuring advice to the "homemakers of America," as she puts it. Martha Radio goes on the air this fall, after she completes her sentence for obstruction of justice involving a stock trade. Stewart promises to play a hands-on role, taking calls from listeners and giving tips on topics from gardening to curtain care.

A big rationale for signing such big names is to drive ad sales, creating a revenue stream in addition to subscriber fees. But Sirius doesn't pay for any of the traditional audience-tracking services like Arbitron, instead surveying listeners by e-mail and phone, so Sirius can't tell advertisers how many folks are listening in a given quarter-hour, a key metric advertisers use to negotiate rates. "Our clients aren't falling over themselves to advertise on satellite radio," says Jon Mandel, chairman of the ad-buying firm MediaCom US. Karmazin says he is confident that his stars will earn their keep. "What makes the difference is content," he says in an interview at Sirius headquarters. "I don't know how you can do it on the cheap."

To folks who know the old Karmazin, the idea of splurging on content sounds like a remarkable change of heart for a guy who became a cult figure on Wall Street as a radio adman, the Infinity boss and a media consolidator focused on the bottom line. After selling Infinity to Westinghouse (which had swallowed CBS a year earlier) for $4.9 billion, he became head of CBS in 1999 and then sold the whole thing to Viacom for $40 billion. He found himself the No. 2 guy at Viacom, behind chief Sumner Redstone. The two clashed famously, in part over personalities and content--Redstone loving the superstar deal, Karmazin leery of it. According to a source close to Viacom, Karmazin referred to the creative folks as the "arts and crafts people." Viacom's Paramount movie studio earned a reputation for pennypinching during his reign, and after Karmazin left, Paramount executives were encouraged to take more risks on potential blockbusters. "Sumner was always Mr. Content Is King, and that was a little in conflict with Mel's natural tendency to drive quarterly growth," says a source close to the execs. Karmazin says he was never that tight with a buck if a deal was worth it. "Didn't I get the NFL back on CBS?" he asks. "My focus on cost has been there throughout my career, including today."

Karmazin concedes that he didn't foresee the potential of satellite radio and raised doubts about its viability as a business model. Just a week before being named CEO of Sirius, he told a broadcasters' conference in Portugal that while Stern made a "brilliant" deal for himself, "the jury is out on whether or not it is good for anybody else." To the old guard at Sirius, Karmazin certainly seemed like a saboteur. "They thought my agenda was to hold back satellite radio," he says of talks he had with Sirius in 2003 about a link with Viacom. What changed his mind? Stern, for one thing, Sirius' deal with the NFL for another, and a lucrative contract to run a publicly traded company for an annual base pay of $1.25 million and 30 million stock options, worth at least $114 million, according to an estimate by Bloomberg.

Some call Karmazin an opportunist--or, more unkindly, a traitor to the old radio business--but nobody ever called him stupid. His strategy of seeding the Sirius lineup with high-priced stars makes sense if it's going to challenge XM, the market leader. XM's chipsets and audio technology, developed in-house, are a generation ahead of Sirius' hardware. Last fall, XM was first to market an iPod-like portable-radio device. The company in 2004 began serving up traffic data in major urban markets, fed directly to a car's navigation system, a feature that Sirius has announced but hasn't launched. Another edge: XM's reported subscriber-acquisition costs of $62, vs. $177 for Sirius in 2004 (Sirius expects the cost to drop to less than $145 for 2005). XM chief Hugh Panero says he can't rationalize signing a star like Stern. "What we do is look at the long-term economics of the programming," he says. "We're less concerned about the p.r. bang of an announcement."

XM also has the edge in the automotive sector, the heart of the satellite-radio market. XM generates 50% of customers with new-car sales (Sirius does better in the aftermarket), and XM's financial backers, GM and Honda, offer XM radios as standard equipment in 62 models, selling the tuners in 30% of their new vehicles. Sirius' partners, such as DaimlerChrysler and Ford, are running at a 10% to 15% installation pace, says analyst Lee Westerfield of Harris Nesbitt. All told, he estimates that XM's automotive partners hold a 10-point market-share lead over automakers aligned with Sirius, amounting to an extra 1.7 million potential customers a year for XM just from the new-car showroom.

The broader challenge for both Sirius and XM, as well as broadcast radio, is to fend off rival audio technologies, from iPods to cell phones that can play MP3s to Internet radio. Consumers like New York City law student Shaina Itkin, 26, say they would love a satellite radio--iPod combo, using the radio to find new music to download. Although there's an iPod dock from TimeTrax for podcasting satellite radio, for now, she says, "my iPod will do." Sprint, meanwhile, launched a radio network this month (see sidebar). And Motorola is testing a service called iRadio that will allow users to download MP3s and content from Internet stations to a cell phone and, from there, beam it to a car stereo. (Internet radio groups like Live365.com aim to charge fees for that.)

Not to be outdone, terrestrial-radio groups are migrating to digital and see cell phones as a content battleground too. The nation's big station groups, including Clear Channel, Infinity and Citadel Broadcasting, are upgrading to enable FM stations to split their signal into multiple, digital streams. That will open up the airwaves for niche formats--all Elvis, all the time--and channels for targeted content like college sports. Digital music channels may also be offered ad-free, for a subscription fee, parrying satellite's advantage. "We're not gonna be on defense anymore," vows Infinity's CEO, Joel Hollander. Like other radio groups, Infinity wants a piece of the cell-phone action. It announced a deal with Hewlett-Packard and Nokia to broadcast radio content to mobile phones. Clear Channel, the nation's largest AM/FM network, also plans to offer content over handsets later this year. And digital radio is expected to be offered in luxury autos such as BMWs this fall.

All this suggests that the satellite guys have a narrowing window of opportunity to build their brands and sign customers before a free-for-all breaks out for the consumer radio buck. While consumers are now locked into choosing Sirius or XM when they buy satellite tuners, that will eventually end with radios that can pick up either company's signal (a regulatory requirement). The recent tit-for-tat content deals and fights over automakers could be just a warm-up to price wars that could whack everyone's bottom line. "The test will be whether XM and Sirius keep their covenant with the consumer that music shall be commercial-free," says analyst Westerfield. As subscriber growth slows, it's only a matter of time, he predicts, before corporate sponsorships creep in, followed by the occasional promo. "We will not have commercials" on music channels, promises Karmazin. More than anyone, he knows that's what helped kill the party before the satellite guys came to town. --With reporting by Melissa August/Washington

With reporting by Melissa August/Washington