Satellite Radio: Is The XM-Sirius Deal Dead?

| About: Sirius XM (SIRI)

The satellite radio stocks have become a quagmire. After months of speculation about the possibility of a merger, XM Satellite Radio (XMSR) and Sirius Satellite Radio (NASDAQ:SIRI) did what the Street had been asking and agreed to merge.

Since the announcement, though, the stocks have headed sharply lower. The Street now seems convinced that the merger is likely to fail in the face of objections from Washington. With both companies struggling financially, the Street does not like the prospects for what happens to XM and Sirius if the merger collapses.

Yesterday morning, two analysts weighed in with detailed reports, and some specific investment advice.

Jonathan Jacoby, an analyst with Bank of America, yesterday trimmed his price targets for both companies, and repeated his Neutral ratings on the two stocks. He cut his estimate of the stand-alone values of Sirius to $2.25 from $2.50, and for XM to $10.50 from $13.50. (His price targets, which reflect some chance the merger goes through, are a bit higher, at $2.75 and $12.50.)

Jacoby cited two reasons for the reductions. For one, he reduced his anticipated long-term conversion rate for XM to be consistent with his forecast for Sirius (the conversion rate is the percentage of car buyers with factory installed satellite radios who actually activate them after a free trial period). He sees long-term conversion rates in the 40%-45% range, down from his previous view of 50%.

Jacoby also lowered his estimate on potential synergies from a merger of the two companies to $3.6 billion from $5 billion, on a concern that the sports rights fees paid by XM and Sirius could actually increase, rather than decrease.

Jacoby says the current stock price suggests the market puts the probability that the merger will close at between 25% and 40%.

Craig Moffett, an analyst with Bernstein Research, thinks the market is even gloomier: he says current stock prices suggest just an 11.2% chance the merger will be approved. In a note yesterday morning, he advises investors that whether or not the deal gets done, the best play is a pair trade: buy XM, and short Sirius.

Moffett notes that as of Friday’s close, XM trades at an 11.7% discount to Sirius, “despite being a better positioned company.” He says XM’s strategic position with automakers is “better” and “only getting more so.” He says XM’s auto partners had 56% of the U.S. auto market at the end of 2004, and now have 59.3% share:

In order to believe that Sirius is justified in trading at an [enterprise value] premium to XMSR, one would have to believe that Sirius, which is still ~21% smaller than XM on a subscriber basis, eventually eclipses XM in scale (and profitability). Since XM already has a roughly 60-40 edge in the OEM market, and the retail channel appears destined to decline in its contribution to the overall market, we think Sirius would need to gain an impossibly high share of the retail market share. In our view, the gap between the two stocks will eventually have to close.

Moffett yesterday trimmed his price targets on both companies. For Sirius, he goes to $3.50 from $4; for XM, to $16 from $19.

Concludes Moffett: “We believe XMSR merits a sizable enterprise value premium, given both its larger size and stronger OEM position. We continue to believe the pair trade represents the most compelling way to participate in the sector.”

Yesterday, XM was down 23 cents at $11.28, a decline of 1.8%; Sirius was off 12 cents, or $2.86, a decline of 4%.

XMSR vs. SIRI 1-yr chart
xmsr siri 240407

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