Shares of Sirius (SIRI) and XM Satellite Radio (XMSR)have fallen over 30% since the reiteration of sell ratings and lowering of price targets for both companies by Goldman Sachs last week.
With the sell off, the combined market capitalization of the companies now stands at just over $5.1B, levels not seen since Q4 of 2003.
At that time, the companies were approximately one fourth their current size in terms of subscribers and revenue.
The Goldman analyst cited slowing sales, competition from other entertainment sources and the outstanding debt of both companies as key reasons for the negative rating, painting a bleak picture for the future of the combined companies and a dire picture if the planned merger does not happen.
There’s no question that the world has changed dramatically since the merger was first announced in February 2007. Since that time the iPod and iPhone (AAPL) have become the music and entertainment platforms of choice, digital radio has recently started to gain traction and terrestrial radio continues to fight on. If the merger is finally approved, the new Sirius is going to have a difficult time competing with these companies as an independent entity. Saddled with billions in debt and considering future capital needs for operations, infrastructure and devices, future financial success looks questionable at best. I, however, do not see the company remaining independent for long.
I anticipate the company will eventually become part of a larger media or media/technology company that could make the required investments to finally realize the long promised financial success of satellite radio. The company that could most benefit by such as acquisition is Microsoft.
There are two key selling points that make the combined entity attractive to a company like Microsoft (MSFT). First and most obvious is content. No entertainment platform will offer breadth of original content that the combined company will have. From Howard Stern and Opey and Anthony, to the NFL and Major League Baseball, to Oprah and Martha Stewart, to CNBC and Bloomberg, music of all genres, etc, etc, etc.
Second and most important is the potential to dominate the automobile environment. Next to the home and work, the automobile is the third most important environment for most people. Currently Microsoft controls the operating system of most home and business computers, and it’s obvious they see opportunity with the automobile. Last year they launched a product called Sync in select Ford vehicles. Sync is an integrated, voice activated communication and entertainment system for wireless handsets and digital music players. The product has been a modest success and will be made available on most Ford, Lincoln and Mercury models later this year. The company has plans to expand the Sync product to other automobile companies in the future.
By acquiring or making a significant equity investment in the new Sirius, Microsoft could establish a dominant position in the automobile environment. Such a venture would give the company an unmatched radio platform, in-car satellite TV capabilities and the future opportunity to deliver internet access and other value added services. Additionally, Microsoft would become the dominant internet radio company and could leverage the content provided by satellite radio to boost their Zune product, finally creating a viable competitor to Apple’s iPod.
As of the end of Q108, Sirius and XM reported net debt of about $2.5B, which when added to their current market capitalization of $5.1B, brings the enterprise value of the combined company to approximately $7.6B. Microsoft could choose to pursue an outright acquisition of the new Sirius for approximately $10B or take an equity stake by making a smaller investment. I see the latter a the quickest way to gain traction as it is less likely to garner scrutiny from the DOJ and the FCC, however with Microsoft and Sirius/XM, you never know! The government seems to have it out for these two companies.
All of this is hypothetical of course, but my hope is the Mel Karmazin has been thinking the same way and is ready to put such a plan into action after the deal finally closes. If not with Microsoft, then with Google (GOOG) or a major media company like GE (GE) and or Disney (DIS).
Disclosure: The author currently maintains an actively traded long position in shares of both Sirius and Microsoft.