Bank of America’s Jonathan Jacoby issued a report on satellite radio yesterday that reads bearish. It seems that Jacoby feels that all of the merger benefits are already built into these equities. Jacoby also outlines some historical mergers of the past in comparison to this merger.
Satellite Radio: Remaining Cautious
Deal is Far from Certain & Market Seems to be Ignoring Operational Issues
Risk/Reward points to caution, in our view. Little upside even if the deal is approved. The market appears to be pricing an almost 90%+ chance of the deal receiving required regulatory approval – PLUS – the ability of the merged entity to extract full synergies (BofAe $3.6B). We estimate that XM and SIRI are worth $15.50 and $3.50, respectively, if the merger is approved and synergies are fully realized (in other words, we do not see much upside from here deal or no deal – although we are keenly aware of market momentum). Following up on our Sept. 3rd report where we outline key issues that the Street might be overlooking, we review the three most common questions we have received over the last 2 weeks.
1) Doesn’t the FCC simply follow (rubber-stamp) the DOJ? And therefore, if the DOJ approves the merger the FCC will simply follow suit? Not always. Historically, the DOJ does take the leadership role in merger decisions. However, there are exceptions; we note the EchoStar/DirecTV merger attempt where the FCC went first. Our contacts believe that the DOJ will probably move first here as well, given where the DOJ and the FCC are in the process.
XM (XMSR)/SIRI(NASDAQ:SIRI)have certified that they have complied with DOJ’s second request for information triggering a 30 day clock – BUT this can and will most likely be extended (according to our contacts), Yes, it is POSSIBLE that DOJ could render a decision before the end of October, but no one knows if the DOJ has all the info it requires to render a decision.
2) Can the FCC simply stall? Shouldn’t we expect a quick decision by the FCC post a DOJ decision? The FCC has stalled in the past – do not forget politics. In several high-profile mergers, the FCC has taken many months (~4) to reach a decision after the DOJ has approved a merger. An example is the Bell Atlantic/NYNEX merger back in 1996. The DOJ approved the deal in April 1997, but FCC approval did not come until August.
Our contacts suggest that the delay may have been for political reasons. And well, we have a political backdrop that hasn’t been seen before (current Pres & VP aren’t running & Congress is in the hands of the opposing party). It will be interesting to see if Congress (re)turns its attention to the merger in an attempt to impact the merger.
3) Isn’t the Whole Foods deal a “signal” on how the DOJ might rule on satellite radio? No. Our contacts believe that the WFMI deal approval CAN’T be extracted to satellite radio. In the case of Whole Foods, the merging applicants simply needed to demonstrate that organic foods were available in more than their two chains – that the barrier to entry was low for selling organic foods.
Evidence was quite easy with all major food store chains now offering expanded organic sections. The satellite radio merger hopefuls need the DOJ to expand the relevant market definition for “audio entertainment”. XM/SIRI seem to have a much tougher job at the DOJ, as they offer a service that no one else can (terrestrial can not offer 150+ nationwide programming w/ commercial free music, indecent content, sports, etc) without any know competitor in the background.
Furthermore, the market tends to be ignoring operational issues. Weaker than expected retail, Rising SAC/CPGA, churn to increase, rev share increasing w/ OEM penetration, and risk to music royalty rates.
Now that Jacoby has outlined his opinion, here is my take on what he had to say:
1. If merger synergies are already built into the price, why do we see continued upward trends on volume as the street sentiment continues to improve?
2. The question about the FCC following suit with the DOJ was never answered. Historically, the FCC has not gone against what the DOJ has decided. Most analysts believe that the DOJ will “lead” the process, but rest assured that there is some coordination between the agencies. This does not happen in a vacuum. The 30 day clock for the DOJ exists, but up until the FCC decision, the DOJ could act, thereby actually giving the DOJ more time. However, this illustrates that the agencies communicate. The DOJ would be very poorly prepared (if they were thinking of blocking) to let the 30 days pass, and then wake up one morning to see that the FCC had made a decision.
3. There is the question about the FCC simply stalling, and cite some historical cases in which this seemed to happen. However, there have been active moves on the part of regulators to streamline the merger and decision process that have happened subsequent to the cases cited. Additionally, for what reason would either agency stall? Further still, the FCC Chairman has stated publicly that he intends to bring the matter to a vote in Q4. Simply stated, there is little indication from anywhere, including the FCC that they will sit on this merger. If they were so inclined, they would stop the FCC timeclock, and request additional information.
4. The Whole Foods deal is interesting to watch, and the correlation that exists is simply that a market can be defined broadly, and courts are more than willing to establish that definition. Satellite radio has many competitors, not all of which broadcast by satellite. The barriers to become an audio entertainment provider can be both big and small. The relevance of the whole Foods merger rests in how the competitive landscape can be viewed. It is not a negative in this case, and a slight positive.
5. Operational issues - SAC for one company is increasing, for the other it is decreasing. Retail is weaker, but OEM penetration is more than offsetting the retail channel. The more cars that come with satellite radio, the less likely you will need to be a retail customer. Churn is stable, and well accounted for with these companies. Revenue share increases are known to exist in the GM deal after the 6,000,000th install expected later this year. Aside from that, most other deals seem to work rather well regarding revenue share. Music rates….Time will tell.
It appears that BOA will continue to be one of the few bears on this process, and that short of an announcement from a regulator, they (as well as their “DC Contacts”) will not change their tune.
Disclosure: Long Sirius, Long XM