Robert Peck of Bear Stearns, one of the more detailed and accurate analysts of the satellite radio sector issued an upgrade for Sirius today. One of the significant points of the report centers around the issue of liquidity, and perhaps clears up common misperceptions about what role XM would play should Sirius require additional financing. Peck points out that Sirius has financing ability that would not require permissions from XM, and thus, the terms of the agreement would not need to change should Sirius pursue additional funding.
For investors in this sector, details such as this lend to stability in the equity, and also to the terms of the merger deal. Such details are very important for investors playing the arbitrage of the merger. Another strong item to note is that Peck feels a higher stock price is justified even when using more conservative metrics and an assumption that the merger does not happen. More details on Robert Peck's summary after the jump...
Sirius Satellite Radio (SIRI-$2.88) - Outperform
The Dog Has Bite and Where's the Bark? Upgrading to Outperform
• INVESTMENT SUMMARY. We are upgrading our rating on Sirius to Outperform with a $4 2008 target. We believe that the merger overhang has overly weighed on the stock, creating attractive risk / reward levels. Further, we think that conservative fundamentals alone support our upgrade; and while we believe the merger closing probability is higher than market sentiment, we think investors can still enter assuming the merger fails. Hence we think Sirius' dog will give its shareholders' investment a strong bite over the next several quarters.
• BASED ON CONSERVATIVE MODEL. In our note, we layout out multiple points on how our model is built conservatively around: subscriber estimates, churn & conversion rates, ARPU & SAC, and overall revenue & cost estimates. Further our base case assumes: the merger will fail, the company will need to raise money, lower estimates than consensus and much lower FCF than the previous company guidance.
• VALUATION. Our $4 2008 target is predicated on a DCF that assumes no merger and therefore $0 in merger synergies. Further, our target is supported by a fully taxed FCF multiple, presenting ~25% annualized potential returns. Hence, we think an approved merger is therefore a free call option for investors.
• FILLING LIQUIDITY GAP NOT XM DEPENDANT. Our model indicates that Sirius will need to raise ~$200m in the next 9 months and ~$300m more to refinance the convertible due in 1Q '09. However, we believe this is not an issue because: the markets are already aware of this and would be very receptive to a funding, the funding can be in stages, and Sirius will not need any XM approvals to do so.
T.S. Position- Long Sirius, Long XM