I wrote in a previous article about how Sirius XM (NASDAQ:SIRI) will face off with GM's OnStar service in the near future as both companies compete for the same customers and begin offering similar services. As I see it, a strategic partnership or merger with GM's (NYSE:GM) OnStar would be an ideal outcome and would instantly propel Sirius XM into a huge dominant leadership position within the industry. Despite the importance of OnStar to GM's business strategy of the future, the only real way for the service to become ubiquitous is for OnStar to operate as a separate company from GM. The conflict of interest represented by GM's ownership in the company far outweigh the benefits that other vehicle manufacturers would derive from installing the service. This has and will continue to hamper OnStar's growth.
While a deal between Sirius XM and OnStar has not been actively discussed in the media, it would be a blockbuster occurrence and there are actually some indications that it might be a future possibility for both companies. This article will examine how a merger or partnership between Sirius XM and OnStar would be possible.
Despite the company's size, remarkably little financial information is available on GM's OnStar subsidiary. Analysts estimate the company has annual revenue of about $1.5 billion and profit margins of 30 to 35 percent. With plans priced from about $25 to $40 per month and over 6.6 million subscribers, those figures actually seem a bit low. By my calculations, revenue should be closer to the $2 billion to $3 billion range, however, if we take into consideration the discounts, trial period subscriptions and likely lower plan prices in the Chinese market, perhaps the true revenue estimate falls somewhere in the middle. An estimated revenue in the low $2 billion range should be likely. As you can clearly see, OnStar is a large company, and considering its growth and the consistent nature of profit generation, it forms a very important part of GM's overall business model.
In 2009, during GM's bankruptcy, the company explored a sale of OnStar that would have valued the company at about $2 billion to $4 billion. In 2011, Forbes circulated a report that GM was considering spinning off its OnStar unit. At the time, a former GM executive said that the unit generates enough profit to justify a market valuation of at least $7 billion. Considering the company's growth, profit margin and dominant market position within a very fast growing industry, that figure actually appears to be reasonable.
Combination with Sirius XM
With the purchase of Agero, Sirius XM is looking to expand its business into the vehicle telematics market. It has plans to offer vehicle diagnostic, navigation and emergency response services. Meanwhile, OnStar is looking to expand its own service offerings by offering more entertainment offerings and connectivity solutions over a 4G LTE cellular network. It would appear that both services will soon be competing with each other with a similar set of offerings. The reality might be something far more interesting and lucrative. Rather than going to war with each other, the two companies might be planning a strategic partnership or merger.
GM has a longstanding partnership with Sirius XM. Not only is the Sirius XM satellite radio service an important option for GM to offer its customers, but GM also receives huge revenue share payments from Sirius XM in return for the OEM installations. Satellite radio is an important business for GM. Meanwhile, OnStar is also vital because of its industry leading technology and large profit margins, far above the 6% to 7% margin GM makes on selling vehicles.
At the same time GM knows that OnStar would be able to grow much faster as a standalone company. And if the company would be spun off or sold, GM would still be able to benefit via a revenue sharing agreement in return for OEM installations. Knowing this, GM has actually been looking to sell off its OnStar unit for years. OnStar has always operated as an independent subsidiary but it is looking more and more like GM might make the business a standalone company.
Logistics Of A Deal
A deal between Sirius XM and OnStar would be hugely beneficial for both companies. Sirius XM would be catapulted into the lead position within the telematics industry and the OnStar service would see massive growth as it could be included as a bundling option with Sirius XM radio. A combined Sirius / OnStar console would form the foundation of a connected vehicle platform, open to all vehicle manufacturers and integrating the best feature from both services. Customers would also benefit from the expanded service offerings, combined billing and likely lower monthly fees as the two companies could consolidate operations and streamline their promotions.
The actual financials which would allow such a merger are harder to anticipate, but certain scenarios can be envisioned which would allow a merger to occur. Each of the cases outlined below are possible and would be beneficial to all companies involved.
GM spins off OnStar - GM could spin off OnStar into an independent company. As an independent company, OnStar would likely experience far stronger growth as more vehicle manufacturers would be willing to install the service. For other automakers, GM's relation to OnStar was always a large conflict of interest. As an independent company, this conflict would be removed. In this circumstance, OnStar and Sirius XM would likely form some sort of a strategic partnership as both companies would benefit greatly from combining their service offerings and together they would be the dominant players in the industry. GM would also likely retain some minority ownership in OnStar and it would also benefit from OEM installation contracts with the company, which pays a share of the residual subscription income from each subscriber.
Sirius XM and OnStar Merge - A merger of this size would be a game changer for both companies and the whole telematics industry. Sirius XM is likely growing much faster than OnStar and with a market cap of almost $25 billion, it is the larger company by far. OnStar has an estimated value of about $7 billion, so it is a rather large company and any prospective buyer would have to have a clear plan for growth. GM would not be willing to sell the company to another automaker, so the potential market for buyers, which could effectively use OnStar to drive profit and growth would be limited. Considering the established relationship GM currently has with Sirius XM, it would be possible that GM might give Sirius XM some preferential treatment in the negotiating process. In other words, GM would rather merge OnStar with Sirius XM and maintain close ties with the company, rather than seeing somebody else take over OnStar and leave GM with nothing.
Liberty Buys OnStar - Liberty Media (NASDAQ:LMCA), a company with far greater financial capacity than Sirius XM could purchase OnStar and integrate the service into their current offerings. Liberty already has de facto control over Sirius XM and if it were to control OnStar too, it could easily integrate the services and drive subscriber growth. The two companies are definitely more valuable as a combined entity and Liberty Media could use their expertise in subscription based business models to drive the value higher than anybody anticipates. Integrating OnStar with Sirius XM would provide a huge boost to shareholders and dramatically increase the value of the combined company. After combining the two companies, Liberty would still be free to spin off the entity, as many shareholders presume, using a Reverse Morris Trust process.
Sirius XM and OnStar are going to be facing off soon, as the business models of both companies converge and they fight over the same market. Rather than entering a long and expensive battle, the two companies would be best served by either merging or forming a strategic partnership. Together, the two companies would form a telematics and entertainment behemoth and see massive growth in the coming connected car revolution. Liberty Media could also get involved to facilitate the merger. Shareholders on all sides would benefit and Sirius XM's share price would get a huge boost.
Disclosure: I am long SIRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.