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In re XM Satellite Radio Holdings Securities Litigation

March 28, 2007


The opinion of the court was delivered by: Ellen Segal Huvelle United States District Judge


Plaintiffs*fn1 seek recovery in this class action for their purchase of stock or stock options in XM Satellite Radio Holdings, Inc. ("XM" or "the company") between July 28, 2005 and February 16, 2006 (the "class period"). XM is a Delaware corporation with its principal place of business and chief operating offices located in Washington, D.C. According to plaintiffs' allegations, on February 16, 2006, XM disclosed that it had incurred significantly increased marketing expenses in its fourth quarter and subsequently XM's stock dropped by nearly 28.5 percent. Since XM had never reported profits, its value and the value of its stock were based on the number of subscribers it reported, as well as on metrics relating to the company's marketing expenditures per each new subscriber. The plaintiffs allege that XM's stated business model was to pursue "cost-effective" growth by consistently reducing marketing expenditures per new subscriber. During the class period, XM had stated it would be able to meet its goal of signing up six million subscribers by year-end 2005. As it tried to meet this target, plaintiffs allege, XM spent extraordinary amounts on marketing without disclosing these expenditures to the market. Plaintiffs contend that XM knew it would be incapable of meeting its target metrics because it had "abandoned" its business model of cost-effective growth, and that several key XM insiders liquidated their own shares of XM stock while in possession of this material, adverse non-public information. Plaintiffs therefore claim that the announcement on February 16, 2006, of the increase in XM's subscriber acquisition costs was foreseeable, and that the company materially misrepresented its financial outlook during the class period.

The consolidated complaint seeks recovery against XM and its Chief Executive Officer, Hugh Panero, for plaintiffs' losses under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5. (Compl. ¶ 107.) It also asserts a "controlling person" claim against Panero under § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). (Compl. ¶ 120.) Defendants have moved to dismiss the consolidated complaint pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4, for failure to state a claim of securities fraud. As explained herein, because plaintiffs have failed to allege any actionable material misstatement or omission by XM or Panero, the Court grants defendants' motion to dismiss.


XM launched its satellite radio service in September 2001, and currently provides satellite radio service in the United States on over 150 digital channels to over six million subscribers. (Compl. ¶¶ 2, 28, 75.) XM's subscribers include consumers who have purchased XM's satellite radios at retail electronics stores, as well as owners and lessors of automobiles manufactured with XM satellite radios which have been installed in the car. (Id. ¶ 2.) XM's stock is traded on the NASDAQ under ticker symbol "XMSR." (Id. ¶ 1.) During the class period, defendant Hugh Panero was CEO, President, and a director of XM. (Id. ¶ 16.) Satellite radio is a relatively new medium, and XM has only one primary competitor in the field -- Sirius Satellite Radio Inc ("Sirius") -- which launched its service in mid-2002. (Id. ¶¶ 4, 31.) Both XM and Sirius offer a variety of music and other audio programming. In October 2004, Sirius made news when it announced that it had signed a deal to broadcast, beginning around January 1, 2006, the daily radio show of media personality Howard Stern, the number one national radio host among eighteen- to forty-nine-year old men. (Id. ¶ 33.) XM offers programming by well-known personalities such as Ellen DeGeneres. (See Valentine Decl. Ex. R. [Brian Steinberg, Advertising: XM Aims to Neutralize Sirius, Stern, WALL ST. J. (Nov. 14, 2005)] at B8.) XM, because it entered the market first, enjoyed an early lead over Sirius in market share, but plaintiffs allege that Sirius was steadily gaining ground on XM in the time leading up to the class period. (Compl. ¶ 35.)

As a new company selling a new technology, XM has not yet turned a profit. (Id. ¶ 36.) Plaintiff's complaint alleges that in lieu of profits, the market focuses on several "subscriber-related metrics" to gauge the health of the company. (Id.; Pl. Opp. at 4.) Most relevant for purposes of this action are subscriber acquisition costs ("SAC") and costs per gross addition ("CPGA"). SAC includes subsidies that XM offers on new radios as an enticement to potential subscribers, distribution expenses, and negative margins from direct sales of merchandise, divided by the number of new subscribers for the relevant period. (Compl. ¶ 41; Valentine Decl. Ex. G [Nov. 9, 2006 Form 10-Q] at 46.) In other words, XM often sells its radio units at a loss in order to gain subscribers, and SAC is an expression of that total loss divided by new subscribers acquired for a given period. CPGA includes the amounts included in SAC, as well as advertising and marketing expenses and ongoing "loyalty payments" to distribution partners, again divided by the number of new subscribers for the relevant period. (Compl. ¶ 41; Valentine Decl. Ex. G at 47.)

Plaintiffs contend that XM consistently "emphasized to the market" that it was achieving rapid subscriber growth in a "cost effective manner" and promoting a trend of "steadily declining" subscriber costs. (Compl. ¶¶ 42, 46, 47). Indeed, immediately prior to the class period, XM reported quarter-after-quarter declines in SAC and CPGA. (Id. ¶46.) However, plaintiffs allege, because of increased competition from Sirius during the class period, XM abruptly decided to abandon its "cost effective growth" strategy for a "growth at any cost" approach, while letting the market believe that SAC and CPGA would continue to decline. (Id. ¶ 47.) In particular, XM launched a widespread marketing campaign called "Listen Large" in the third quarter of 2005, designed to counter heavy promotion by Sirius of its deal with Howard Stern. (Id. ¶ 48.) This campaign reportedly cost XM $25 million, but plaintiff's complaint alleges that XM actually spent between $100,000,000 and $150,000,000 on this advertising. (Id. ¶ 49.) In addition, the complaint alleges, XM drastically reduced the prices of its radios and offered other special promotions and rebates during the class period, in part to combat product supply shortages. (Id. ¶¶55-58.) The complaint also alleges that "a former SVP of Human Resources employed at XM during the Class Period commented that the major marketing and subscriber growth initiatives undertaken during the fourth quarter of 2005 (including Listen Large) had been fully budgeted well in advance because it was known as early as October 2004 that Howard Stern would begin broadcasting on Sirius in January 2006," and that the witness "said these costs could simply not be viewed as any kind of surprise or unanticipated event." (Id. ¶ 51.) These business decisions, which apparently generated fewer new subscribers than XM had forecast, caused SAC and CPGA numbers to increase substantially in the fourth quarter of 2005: SAC increased approximately 39% and CPGA increased approximately 36% compared to the fourth quarter of 2004. (Id. ¶¶ 75, 77.) Plaintiffs claim that XM's failure to disclose its "concealed change in business philosophy" to the market, which artificially inflated XM's stock price during the class period, is actionable under § 10(b) and Rule 10b-5. (See Pl. Opp. at 8; Compl. ¶ 107.)

Plaintiffs quote extensively from a number of statements made on five separate dates during the class period that they contend were materially false or misleading. (See Pl. Opp. at 6 n.6). These statements are discussed below.

I. July 28 and August 2, 2005 Statements

On July 28, 2005, XM issued a press release announcing its financial results for the second quarter of 2005. (Compl. ¶ 59.) The company's revenues had more than doubled over the second quarter of 2004, and it reported "Efficient Quarterly Subscriber Growth," with CPGA at $98, compared to $101 for the second quarter of 2004. (Id.) The press release also announced that XM had increased its 2005 subscriber guidance from five-and-a-half million to six million ending subscribers for 2005, based on their "first half performance and an even stronger outlook for the second half of the year." (Id.) That same day, XM hosted a conference call with investors and financial analysts to discuss its second quarter 2005 earnings and financial outlook. During the call, defendant Panero reiterated the increased subscriber guidance of six million year-end subscribers and also announced that SAC and CPGA had improved over the second quarter of 2004: SAC had dropped 12% from $57 compared to $50, and CPGA had dropped 3% from $101 to $98. (Id. ¶ 60.) He stated that the company was "achieving rapid growth with sound financial performance." (Id.) XM's Chief Financial Officer, Joe Euteneuer, added that XM's "efficient marketing efforts have enabled [them] to continue demonstrating cost-effective subscriber growth," reflected in SAC and CPGA improvements, and stated: "We expect CPGA to remain stable during the second half of the year." (Id. ¶ 61.) Later in the call, during a question and answer session, someone asked the XM representatives whether they expected SAC to remain stable in the second half of the year as well. (Id. ¶ 62.) In response, an unidentified XM representative reiterated that they thought CPGA would be stable, but stated that "SAC [can] bounce around a bit depending upon what your actual hardware subsidy elements are on any given timeframe." (Id.) The XM representative then re-emphasized the improvements in SAC and CPGA results over the previous year's numbers. (Id.) Additionally, when asked whether XM viewed Howard Stern's new programming at Sirius as a risk to its growth estimates, an unidentified XM representative remarked that "the announcement of Howard Stern['s deal with Sirius] has been in the marketplace for almost 1.5 years now, so we have seen no effect of that at all during that period . . . . That has been around for awhile, so we continue to have strong demand." (Id.) The representative noted, "clearly we would not be upping our [year-end subscriber] guidance if we thought that there was an issue with regards to how he would affect demand for our product." (Id.)

On August 5, 2005, XM filed its interim quarterly financial report, Form 10-Q, for the second quarter of 2005.*fn2 The 10-Q stated that during the second quarter, XM continued to "grow [its] gross margin . . . while reducing [its] costs to acquire each new subscriber." (Id. ¶ 64.) The form also reported the SAC and CPGA numbers that had been announced on July 28. It noted that "timing of promotions and new contracts may cause SAC to fluctuate from period to period," and "timing of media campaigns and discretionary advertising spending may cause CPGA to fluctuate from period to period," but the form stated that the company expected both SAC and CPGA "to decline in 2005 as compared to 2004." (Id.) The 10-Q also stated: "We are pursuing a business plan designed to increase subscribers and revenues while reducing or maintaining subscriber acquisition costs."*fn3 (Id.)

Plaintiffs claim that these statements "were each materially false and misleading when made as they misrepresented and/or omitted adverse facts which then existed[,] and disclosure of which was necessary to make the statements not false and/or misleading." (Id. ¶ 65.) Specifically, plaintiffs allege that Panero and other XM officials then knew, based upon their "access to and review of internal XM data," that XM "would be forced to spend extraordinarily large sums of money in the fourth quarter of 2005" because of "competitive factors," including the arrival of Howard Stern at Sirius, in order to achieve its year-end goal of six million subscribers, and that XM was accordingly planning to spend large sums on the Listen Large campaign in the fourth quarter of 2005, which would cause SAC and CPGA to increase dramatically. (Id.) Plaintiffs argue that XM failed to disclose these planned expenditures to the market, despite knowing that the market expected SAC and CPGA to decline in the second half of 2005 because of XM's statements "highlighting" its ability to increase subscribers while reducing subscriber acquisition costs. (Id.)

II. October 27, November 1, and November 7, 2005 Statements

On October 27, 2005, XM issued a press release announcing its third quarter results and reaffirming its six million year-end subscriber guidance. (Id. ¶ 67.) It reported that SAC had decreased to $53 compared to $57 in the third quarter of 2004, while CPGA was stable at $89 in the third quarters of both 2004 and 2005. (Id.) The press release also stated that "XM expects to accelerate its subscriber and revenue growth through the fourth quarter." (Id.) Also on October 27, 2005, XM hosted a conference call to discuss its third quarter results and financial outlook. (Id. ¶ 68.) During that call, Panero stated:

The secret to XM's smart subscriber growth rather than growth at any cost is the ability to control marketing and product expenses while rapidly growing subscribers. This quarter, XM kept its fully loaded per unit costs of capturing a new subscriber, or CPGA, constant at $89 -- the same CPGA we reported in the third quarter last year. These results provide us the flexibility to aggressively advertise and market our service in the fourth quarter. And in fact, that is what we are doing -- implementing a comprehensive media campaign comprised of advertisements, rebates, and other promotional techniques to fully exploit the holiday selling season again this year.

(Id.) Similar to his comments in the August conference call, Euteneuer stated that "XM's targeted and efficient sales and marketing efforts have enabled [them] to continue to demonstrate cost-effective subscriber growth," reflected in decreased SAC and stable CPGA as compared to the third quarter of 2004, but he also warned that "[s]imilar to past trends, [they] expect fourth quarter SAC and CPGA to increase due to greater media and promotional activities during the upcoming holiday season."*fn4 (Id.) Euteneuer also reaffirmed the six million year-end subscriber guidance. (Id.) Later in this conference call, the XM representatives were asked about the potential effects of the increased "level of rebating" for XM's radios going into the holiday season. (Id. ¶ 70.) Steve Cook, an XM representative, replied that their "intent there is . . . to hit lower and lower price points [on their radios] to really penetrate the mass-market," and that these subsidies on XM's hardware would be reflected in SAC. (Id.) He further remarked that XM "can maintain [its] SAC at very reasonable levels and still hit some of these attractive consumer price points."*fn5 (Id.)

On November 1, 2005, XM issued a press release "highlighting" the fact that it had increased its retail market share to 59% in the third quarter of 2005, compared to 56% in the second quarter. (Id. ¶ 72.) In the press release, Panero is quoted as saying "XM continues to expand its leadership position while adding subscribers at about one-third the cost of our competitor." (Id.) Then on November 7, 2005, XM filed its 10-Q form reporting financial results for the third quarter of 2005, which were "substantially similar" to those reported in the October 27th press release, and reflected decreased SAC and stable CPGA as compared to third quarter of 2004. (Id. ¶ 73.) The 10-Q stated that XM had continued to "grow [its] subscription margin . . . while ...

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