Lehman issued a Q2 preview note on XM Satellite Radio today.

Report Excerpts:

- Investment Conclusion

Newly announced pricing plans include a la carte and family-friendly features that we believe are designed to appeal to FCC Chairman Martin. Plans are contingent on merger approval. Believe a la carte would be largely revenue neutral, resulting in more subs (due to lower entry price point) but lower ARPUs. Remain bullish on satellite radio industry whether merger occurs or not, continue to view merger synergies as substantial, retain 1:OW.

- Summary

A la carte offerings include limited plan for $7/month - likely to increase subscriber base at lower ARPUs due to lower price point. Plan's appeal limited as it requires a new radio, so existing retail sub base and all OEM units are ineligible. Family-friendly plan is primarily political - rebate is small enough that few customers are likely to block the content solely to receive the rebate. 2Q07E key estimates: 948k gross adds, 333k net adds, $74 SAC (new formula), $118 CPGA, $10.15 ARPU, $276MM revenue, ($45)MM adjusted EBITDA loss, ($75)MM FCF loss.

- XM and Sirius’s new pricing plans are primarily designed to have a political effect: the inclusion of a la carte and family-friendly offerings address two key policy goals of FCC Chairman Kevin Martin.

We believe the a la carte plans are likely to be roughly revenue-neutral, as lower ARPUs (due to subscribers taking lower priced plans) are offset by increased subscribership due to the lower entry price point. We view the family-friendly option as primarily political: the rebate for blocking objectionable content is small enough ($1), and the channels lost significant enough (including the uncensored music channels), that we expect the plan to primarily appeal to customers who would have blocked objectionable content in any case

- A la Carte Packages – Lower ARPU, But Could Stimulate Subscriber Growth

New Radio Required. XMSR and SIRI, if allowed to merge, plan to offer two a la carte packages. We believe these packages are designed to appeal to FCC Chairman Kevin Martin, who has made a la carte a priority in his dealing with the cable industry.

The first a la carte package, for $6.99/month, would allow XM customers to choose 50 channels from an array of 100 existing XM channels. The 100 channel array would not include premium content such as MLB, Opie & Anthony, or Oprah. The second package, at $14.99, would allow XM customers to choose 100 channels from all of XM’s programming and a selection of approximately 10 of Sirius’s most popular channels (likely including Stern, Martha Stewart, and the NFL). These Sirius channels would be distributed over the existing XM satellite network. Customers will be required to go online to choose and update their channel selections, which should keep customer service costs under control. The companies estimate that this service could be available by late 2008.

It’s important to note that both of these a la carte packages will require a new radio (due to a change in the chipset), and hence will beunavailable to the entire installed base of OEM subscribers along with retail subscribers who do not wish to upgrade their radios. As a result, we believe that cannibalization of existing subscribers is likely to be limited, while a la carte could increase retail gross adds and OEM conversion rates through the lower $7 price point.

- Tiered Programming – Add-Ons Could Boost ARPU But Music or News/Talk Only Packages Have Limited Appeal.

XM and Sirius announced plans to allow customers (post-merger) to access approximately 10 channels of the other provider’s programming for an additional $4/month. While the actual channels have not been announced, we believe that the additional channels would be premium content like Stern, Opie & Anthony, NFL, MLB, Oprah, Martha Stewart, etc., as there would be limited value in allowing customers access to another 80s music channel, for example.

These new packages (at $17/month) will be less expensive than purchasing full subscriptions to both providers (which would cost $26/month), although we don’t believe that there are currently a material number of customers who purchase both services. These tiers will require a billing system upgrade, but should be available (assuming the deal is approved) by mid-08, and will not (unlike the a la carte offerings) require customers to acquire a new radio.

In addition to these add-on packages, the companies are offering to launch a music-only tier with 65 music channels and a news/talk tier with 60 channels, each for $9.99/month – we view the appeal (and cannibalization risk) of these services as limited for most subscribers, as subscribers would lose entire categories of programming (either music or news/talk) while reducing their bills only modestly.

- Family-Friendly Packages – Primarily Political: Discount Not So Large As to Cause Cannibalization.

XM and Sirius are offering to not only block potentially objectionable content on subscriber request (something that’s available today), but to actually give customers a credit ($1 off a standard package or $2 off a package with all of one provider’s content plus 10 channels of the other provider’s premium content) if they choose to block this programming.
We believe the pricing of this offer is designed to show the companies are not “forcing customers to pay for content they don’t want,” while at the same time not providing so large a discount that customers who aren’t interested in Stern or Opie and Anthony, but don’t actually object to the content, aren’t likely to take the family-friendly package just to save money. As a result, we would expect this plan to attract few customers who wouldn’t block objectionable content even if there were no rebate involved
- 2Q07E Expectations.

We are slightly adjusting our 2Q07E forecasts, and incorporating a change in the calculation of SAC into our models. While this change does alter SAC, it does not impact our actual acquisition expense forecasts, nor does it change CPGA.

- Subscribers.

We expect XMSR to add 950k gross subscribers and 333k net subscribers in 2Q07, up 2.3% and down (16.4)% YoY, respectively. We now forecast total churn (including the impact of trial subscribers who don’t convert to paying status) of
2.5%, essentially flat YoY.

- Acquisition Costs.

We now expect SAC of $74, using the new calculation methodology, which now includes loyalty payments to distributors. Net of this methodology change, our SAC estimate was unchanged, and is essentially flat YoY. Our CPGA estimate increases marginally to $118 from $117. The company’s CPGA could come in $2-3 higher, however, as we believe the company
is contemplating a non-cash write-down of obsolete inventory.

- Revenue and EBITDA.

Our ARPU forecast declines slightly to $10.15 from $10.23, reflecting continued growth in the proportion of subscribers on the discounted family plan. We now expect revenue of $276MM and an EBITDA loss (not including merger costs or stock compensation) of ($45)MM.

- Capex and FCF.

We expect 2Q07E capex of $41MM and an FCF loss of ($75)MM

Position - Long Sirius, Long XM