Highly respected sector analyst Bob Peck of Bear Stearns issued a detailed note today regarding the satellite radio sector. The note highlighted the business model of satellite radio as well as the proposed merger, which the analyst feels will pass. Peck has taken a more conservative stance on the value of merger synergies, but also notes that other forms that did the merger review for Sirius and XM had access to more material from which to base their estimates. That being said, Pecks conservative estimate of $5 Billion by the end of 2008 should be welcomed news to long investors in this sector.
After Deal Closes, New Pricing Schema Actually Accretive to Model
• INCREASING OPTIMISM REGARDING MERGER APPROVAL The Street appears tobe increasingly coming around to our view that the merger is likely to muster the approval of both the DOJ and the FCC. Some have turned more positive on the likelihood, but think satellite radio is giving up too much (possibly destroying satellite radio's future business model) to address concerns at the FCC.
• THE NEW PRICING SCHEMA W/ A LA CARTE IS ACCRETIVE, NOT DESTRUCTIVE. However, while nobody knows for certainty what the implications will beon the business model (subs, arpu, churn), our analysis indicates that the new pricing schemais actually accretive. In fact, while many investors think a la carte would obliterate the ARPU of the combined entity, applying a normal distribution curve to the potential pricing options actually shows minimal impact. Further, while we believe ARPU is largely unaffected, gross adds should increase, and churn should decrease (more choice / lower prices).
• POTENTIAL SYNERGIES VALUED AT $5 Billion. Separately from analyzing the pricing schema impact, we have updated our deal synergies estimates, which we last analyzed on January 23, 2007. To reflect the continued industry pressures and too be more conservative, we have updated our analysis. Our estimates now suggest that the two companies could generate an incremental $850 million in pre-tax synergies by 2013, which would result in a tax-adjusted NPV of synergies at about $5 billion at 2008 year end.
• IMPLICATIONS FOR SHARE PRICE. Our conservative projections (assuming nomerger) for both the companies yield DCF-based target prices of $4 for Sirius and $16.50 for XM at 2008 year-end. Should the merger be approved and synergies be realized, our model indicates that Sirius could be worth about $5.50/share and XM$23.50/share at 2008 year-end.
1. WE CONTINUE TO BELIEVE THE MERGER WILL PASS
The Street appears to be increasingly coming around to our view (03/22/2007 Satellite Radio Merger “Will It be Approved?”) that the merger is likely to muster approval of both the DOJ and the FCC, and is likely to be close before year-end. The clock for the DOJ started on September 4, 2007 when both Sirius and XM certified to the DOJ their “substantial compliance” with the DOJ’s second request. The FCC continues to evaluate the merger within its 180-day timeline, which ends in early December, and has not stopped the “clock” even once during the process. While FCC Commissioner Michael J. Copps has said that the deal faces a “high hurdle,” this was only expected, and we think it is likely that both Democrat commissioners vote against the deal. However, for the merger to be approved at the FCC, a simple majority of the five-member Commission is sufficient, which likely would be the three Republican Commissioners, and Chairman Kevin Martin has publicly stated that he likes the proposals that two companies have offered in their recent filings. Sirius and XM recently issued proxy documents to shareholders seeking a vote on the merger on November 13, 2007, which, along with the 180-day FCC “clock” which ends on December 6, 2007, likely will accelerate the regulatory process. In sum, we believe that the proposal of “more choices and lower prices” which allows the companies to share the efficiencies arising out of the merger with consumers has solidified the prospects of the merger being approved.
2. POST MERGER, THE NEW PRICING SCHEMA W/ A LA CARTE IS ACCRETIVE, NOT DISTRUCTIVE
One of the comments we have heard from investors who were previously bearish on the chances of getting the mergerdone, was that they have turned more positive on the chances because satellite radio “gave up so much to appease the FCC with the proposed pricing schema and a la carte offerings.” In essence, these investors state that since satellite radio is giving up so much (possibly destroying satellite radio’s future business model) to address concerns at the FCC, that it ismuch more likely the deal would be approved. However, while nobody knows for certainty what the implications will be on the business model (subs, arpu, churn), our analysis indicates that the new pricing schema is actually accretive. In fact, while many investors think a la carte would obliterate the ARPU of the combined entity (due to the $6.99 option), applying a normal distribution curve to the potential pricing options actually shows minimal impact. Further, while we believe ARPU is largely unaffected, gross adds should increase and churn should decrease (more choice / lower prices).Hence, we think upon deal approval and new pricing implementation, that the DARS business model in fact improves. Note: we also think that it’s important for industry observers to differentiate from package pricing (which clearly declines) and ARPU (which is minimally impacted).
3. Potential Synergies Valued at $5 Billion.
Recall, in our note “MergeCo Synergies Could Reach $6.7B” dated January 23, 2007, we had identified merger-specific synergies of about $6.7 billion that primarily arose from cost efficiencies. Since then, however, fundamentals have continued to remain weak. Given the revised pricing proposal, in this note, we are re-evaluating the potential synergies arising out of the merger. Our analysis suggests that the two companies could generate an incremental $850 million in pre-tax synergies by 2013, which would result in a tax-adjusted NPV ofsynergies at about $5 billion. Note, our analysis does not include any capital expenditure-related savings as the two platforms are likely to continue operating over the near-to-mid term. Sirius CEO Mel Karmazin has publicly stated at the 2Q07 conference call that an independent third party had estimated potential synergies in the “hundreds of millions of dollars” with the NPV being at the high-end of the Street estimates. We understand that the third party had access to the two companies’ books and confidential agreements, which likely imply that they have a much better sense of the potential revenue opportunities as well as the cost savings – however, in this note, we present our conservative assessment of the synergies based on the publicly-available documents.
4. Implications for Share Prices.
Our conservative projections for both the companies yield DCF-based target prices of $4for Sirius and $16.50 for XM at 2008 year-end. In the analysis we are highlighting in this note, our model suggests synergies would be worth about $5 billion at 2008 year-end, implying that Sirius could be worth about $5.50 per share and XM at $23.50 per share at 2008 year-end, should the merger be approved. If we discount back the valuations with synergies to today, we think the fair value of the stocks should be $5 for Sirius and $20 for XM, both significantly higher than current levels.
Position - Long Sirius, Long XM