Obstacles to an XM, Sirius Merger

To go beyond talk of joining forces, the rival satellite radio services must get in tune with regulators, shareholders, and their own executives

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When they first launched at the International Consumer Electronics Show in Las Vegas in 2001, the two major satellite service companies XM Satellite Radio and Sirius Satellite Radio were bitter rivals.

So bitter, in fact, that executives from both companies took every chance they could to smack each other down in public. In press conferences and statements, they'd decline to refer to each other by name. And though their spaces on the trade-show floor were near each other, the walls of each were positioned so that you couldn't see one when standing in the space of the other.

Half a decade later, officials from XM and Sirius are talking about each other a lot—and now it's in reference to a possible merger. Public statements by Sirius (SIRI) Chief Executive Mel Karmazin, its Chief Financial Officer David Frear, and XM (XMSR) Chairman Gary Parsons indicate the companies are circling each other, wondering if it would be worthwhile to bury the hatchet.

Satellite Slowdown

The public chatter gives rise to a host of questions that will have to be worked out when and if the two sides consummate a deal. For starters, would a merger make financial sense, how would it be structured, and will regulators concerned about the formation of a monopoly let a deal go through? And importantly, will larger-than-life executive personalities get in the way?

Sirius' Karmazin fired the start gun on a round of merger speculation in June when he expressed interest in buying XM at a fair price. And judging from the slump in XM's stock, the price is getting fairer all the time. The shares closed at $14.81 on Dec. 7, giving XM a market value of less than $4 billion, or about half of what it was at this time a year ago. Slowing sales growth and losses that have widened each year of its existence have hammered the stock, making it one of the worst performers on the NASDAQ stock market this year.

The picture at Sirius isn't much better. Sirius stock closed at $3.88 on Dec. 7, up 5 cents, or more than 1%, on the merger talk. It had taken a beating two days earlier on news that the company wouldn't add as many subscribers as expected this year (see BusinessWeek.com, 12/5/06, "Sirius Sings the Holiday Blues"). The company said it would finish 2006 with 5.9 million to 6.1 million customers, vs. a previously forecast 6.3 million.

Numbers Favor a Deal

Not everyone's convinced the companies should or will get together. "It's all hype sparked by lowered guidance from Sirius," says Chad Bartley of Pacific Crest Securities in Portland, Ore. "I think that to talk about a merger at this point in the satellite radio growth curve is premature."

Still, others say a merger may happen in 2007. Companies led by Karmazin have made more than 20 major acquisitions worth a combined $80 billion, wrote Kit Spring, analyst with Stifel Nicolaus in Denver, in a research report issued Nov. 27. A successful merger would create as much as $7 billion in shareholder value and carries a risk of destroying only $1 billion, he notes. "Unlike most media mergers, we calculate revenue and dramatic expense synergies in a merger—around 50% of the combined market enterprise values," he wrote.

The potential for cost savings is clear. Customer-acquisition costs at Sirius amounted to $183 a head in its most recent quarter, vs. $60 a head at XM. Combining the marketing and sales operations would likely cut costs at both. And the companies' combined heft would help them negotiate better terms on manufacturing, purchases, and partnerships with auto companies eager to install satellite radio devices in cars.

"Financially, it absolutely makes sense," says Banc of America Securities analyst Jonathan Jacoby.