With the merger having center stage, and rumors seizing control of both Sirius and XM, it was refreshing to see some analysis that stepped away from the fray issued today. Morgan Stanley was a consultant to Sirius during the negotiations that eventually led to a merger announcement. Because of their work with the process, the firm was restricted from publishing a rating, estimate or a price target. The firm is no longer under full restriction. Morgan Stanley is now on what is termed a partial restriction. This enables the firm to now issue estimates. They can still not publish ratings or price targets.

REPORT EXCERPTS ON SIRIUS

Updating Forecast for Lower Retail, Higher OEM Growth

What's Changed

- 4Q07 OEM Net Adds From 375K to 450K
- 2008E Revenue From $1.35 bn to $1.31 bn
- 2008E Pre-Mkt. EBITDA From $525 mm to $460 mm

Conclusion: We are publishing a new forecast after coming off full restriction on SIRI. Our last public estimates were published August 1st. On a standalone basis at SIRI, we anticipate further retail net additions weakness in 2008E as growing satellite-radio vehicle penetration levels evolve into the dominant avenue of subscriber growth for SIRI. Our standalone forecast continues to expect SIRI to reach FCF breakeven in 2010 and is based on 1) an estimated $2 rate increase implemented in ’08 and 2) continued net cash from working capital particularly from pre-payments in the year of the price increase. Without these two variables, our SIRI FCF breakeven date shifts to 2013.

Total 2008 Net Adds Relatively Unchanged: A lower outlook for retail net additions in 2008 is offset by higheradditions estimates for the OEM channel. We are maintaining our FCF (CFFO less capex) breakeven date expectation of 2010 and believe SIRI is fully funded. For CY08E, we expect approximately 1.4 mm SIRI equipped Ford additions compared to our previous 1.1 mm expectation.

Investment Case Summary & Conclusions

We have been on full restriction on SIRI, unable to have a rating, price target, or published estimates. This report is a result of moving to partial restriction, which allows us to have published estimates, but no rating or price target. This forecast updates the last published estimates, from August 1st.

We are updating our subscriber outlook for SIRI given continued weak results from the retail channel, which we believe has been impacted by weakening consumer demand as well as from cannibalization from the OEM channel. We continue to expect SIRI to reach FCF breakeven in 2010. Changes to Our Model We highlight the following changes to our estimates:

•Lowering Retail Estimates: We are lowering our FY08E retail net addition estimate from 547K to 303K mm due to our reduced outlook for SIRI retail subscriber growth. Weaker SIRI retail sales likely stem from more modest consumer interest as well as the partial cannibalization from an aggressively ramping OEM channel.

•Modestly Increasing OEM Penetration Rates: We are increasing our SIRI OEM penetration estimate by 300 basis points to 23.6% or by 300K additions. Our increased outlook results form our raised Ford estimates. We anticipate Ford adding roughly 1.4 mm adds in CY08E compared to our previous 1.1 mm estimate.

SIRI Could Reach FCF Breakeven in FY10

Our model currently assumes SIRI reaches free cash flow breakeven in FY2010, unchanged from our previous estimate. We assume SIRI will end FY10E with $50 mm of FCF (CFFO less capex) in-line with our prior expectation. Our FY10 outlook assumes adjusted EBITDA of $145 mm and $260 mm of capex.

It is important to highlight our current FCF breakeven outlook assumes a $2 monthly rate increase implemented during 2008. Prior to the proposed merger announcement in early ’07, SIRI indicated that it believed the market could shoulder a meaningful rate increase without materially slowing subscriber growth. However given recent merger pricing commentary, SIRI may be less willing to implement a rate increase. FY08E working capital would decline below our estimate of $400 mm should it decide to keep its current $12.95 rate in place.


No Rate Increase Could Call for Further Funding Exhibit 2 shows the impact to SIRI FCF excluding our assumed $2 rate increase as well as FCF without the benefit of material positive working capital from the build-up of deferred revenue payments related to seasonally high new holiday subscriptions.

As mentioned, our current model (which includes the assumed $2 rate increase) anticipates FCF breakeven occurring in FY10. If we were to strip out the anticipated $2 rate increase, we believe SIRI would not reach FCF breakeven until 2012. Under this scenario, CFFO would fall roughly $200 mm to $385 mm in FY12E.

In addition, we believe SIRI would not reach FCF breakeven until 2013 in a scenario where the company did not implement the $2 rate increase, and ignored the impact of cash from working capital. 2012 FCF would fall from roughly $55 mm to roughly -$140 mm. We note that our estimated working capital impact in 2013 is minimal compared to the last several years where retail sales were a much larger portion of SIRI subscriber growth. As the OEM channel continues to become the more dominant avenue of growth, we expect the working capital swings experienced during 4Q over the last several years to moderate.

Penetration Gains Outweigh Weak Auto Trends

SIRI has maintained its retail share advantage over XMSR, but has still experienced disappointing sales trends over the last several quarters. For FY08E, we estimate SIRI retail gross additions will decline 18% compared to down 4% in our previous model.

We believe consumers’ perception of SIRI as the content leader may be partially responsible for the share advantage, but the company’s relatively younger and less saturated OEM presence may have also contributed to a less severe cannibalization of retail adds, we believe. XM has a roughly two-year head start over SIRI in equipping vehicles with satellite radios.

Our FY07E 20% retail gross adds decline estimate for SIRI places greater importance on the OEM channel to drive subscriber growth going forward. As shown in Exhibit 5, SIRI’s OEM channel has grown from roughly 20% of net additions in 2004 to 70% for FY07E. By 2010E, we believe SIRI subscriber growth will fall solely dependent on OEM adds.

SIRI’s OEM channel has managed to weather weak domestic auto trends through aggressively targeting increased penetration targets as well as new OEM agreements. The company has grown its OEM gross additions by approximately 120% in FY06 and by an estimated 80% YoY in FY07E. Much of this growth has come by way of SIRI’s two largest OEM partners- Chrysler and Ford which we believe have roughly doubled their penetration rates from 30% to 60% and 17% to 34%, respectively in FY07E.

XMSR/ SIRI Merger Potentially Drives Cost Savings and Incremental Subscriber Growth

It is possible that the new proposed service tiers (see Exhibit 6)could help to revive retail subscriber growth trends, but we believe improved subscriber growth would more likely result from more attractive OEM self-pay conversion rates instead. Improved OEM conversion is especially beneficial in that the additional customers carry 70+% contribution margins with very little incremental CPGA.

Tiered Offering Impact Unknown

We believe proposed programming tiers could potentially benefit subscriber growth by providing a wider array of content at more attractive price points, but its impact to the mergedcompany falls dependent on consumer take-rates of the various offerings. The merged company would continue to offer subscribers their current programming packages at the existing $12.95 price, but would also offer a la carte bundlesstarting at $6.99 for a 50- channel package. The companywould also offer family targeted packages starting at $11.95 as well as 50 channel music and talk specific packages priced at $9.99.

We asses the potential merger value by using three main scenarios:

•Scenario 1: Fixed Cost Savings: Reduction of research and development, and general administrative, and variable content and programming related expenses

•Scenario 2: SAC/ CPGA Savings: Reduction of marketing and retail commission expenses related to competing satellite radio platforms and improved content offerings

•Scenario 3: Incremental Sub Growth: Improved OEM conversion ratios as well as more attractive retail demand

Potential for Overhead Reductions from Merger

We believe the merger of the XMSR and SIRI platforms would likely allow for the reduction of dual G&A, R&D, and variable content and programming expense buckets resulting in roughly $1.4 bn of merger synergies. While larger on-air talent contracts such as Howard Stern would likely have to be renegotiated upwards due to larger listening audiences, we believe the merger would provide more negotiating leverage with the platforms’ condensed programming talent. The current sports (i.e. MLB, NBA, NASCAR) contracts would remain in-place until the contracts reached their expiration dates which are not due for several years.

In addition, we believe the current revenue share agreements with OEM partners would also remain in place given the ever- increasing importance of the OEM channel to subscriber growth. Reductions in R&D channel would likely come only after near term technology needs related to the interoperability of both platforms were addressed.

SAC/ CPGA Reductions Could Result from Merger

We believe the early value produced from a merger would result from reductions in the marketing and commission components of CPGA. Reductions in radio subsidies would likely take longer to emerge as new, interoperable radios would likely be more expensive than the current stand-alone radios and thus require greater subsidies. We believe reductions in commission and promotion expenses would result from increased bargaining power with the retailers and from the more attractive programming lineups of the merged company. It is also important to note that we believe subscriber growth would be unaffected by the company’s more modest marketing campaign.

Incremental Sub Growth Could Result from Improved Conversion Ratios

We believe a XMSR and SIRI merger could drive incremental subscriber growth from both slower retail gross additions declines as well as improved OEM conversion rates. We estimate that retail gross adds would improve approximately 5% annually and that roughly 10- 15% of subscribers who would have typically disconnected service after the promo period decide to stay on. We note that both our retail and OEM estimates could be conservative. Improved OEM conversion rates are particularly beneficial as they carry significantly higher contribution margins as the initial CPGA has already been incurred. We estimate the improved rates could add approximately 4 mm new OEM subs byYE17E, which would add roughly $4 bn of incremental revenues through the forecast period (’08E- ‘17E).

REPORT EXCERPTS ON XM

XM Satellite Holdings Updating Forecast for Lower Retail Expectations, Later FCF Breakeven

What's Changed

- 4Q07 Retail Net Adds From 150K to 65K 4Q07

- OEM Net Adds From 403K to 323K2008E

- Pre-Mkt. EBITDA From $545 mm to $475 mm

Conclusion: We are publishing a new forecast after coming off full restriction on XM. Our last public estimates were published July 27th. We have lowered our outlook for retail adds, as it appears the increased availability of satellite radio service in newly manufactured vehicles is cannibalizing the retail sales channel. This lower forecast pushes out our estimate ofFCF breakeven for XM standalone from 2010 to 2011. Our current forecast assumes XM will need to borrow from its existing credit facilities in 2008.

What's New: We are lowering our standalone FY08E and long term subscription estimates and pushing back our FCF (CFFO less capex) breakeven date expectationto 2011. We have lowered our FY08E net adds estimate from 1.57 mm to 1.33 mm, implying XM would end the year with approximately 10.3 mm subscribers. We have also layered in the recent music rights decision from the copyright arbitration board (CARB), which contributed to a reduction in our estimate for pre-marketing margins in 2008 from 37% to 33%

Investment Case Summary & Conclusions

We have been on full restriction on XMSR, unable to have a rating, price target, or published estimates. This report is aresult of moving to partial restriction, which allows us to have published estimates, but no rating or price target. This forecast updates the last published estimates, from July 27th.

We are updating our subscriber outlook for XMSR given continued weak retail results that we believe have been impacted by weakening consumer demand as well as cannibalization from the OEM channel. These changes haveled us to reduce our projected FCF breakeven date out one year to 2011.

•YE08E retail gross addition estimate lowered to1.08 mm from 1.40 mm previously. We have lowered our FY08E and long- term retail subscription growth estimates as we do not see any near term catalyst that would likely reaccelerate retail sales in the near term. We now estimate FY08E XMSR gross additions will decline 13% from FY07E compared to no growth previously.

•YE08E OEM gross additions raised from 4.48 mm to 4.56 mm. We have modestly increased our FY08EOEM forecast as a result our raised expectations for GM additions. GM has set a XMSR equipped target of 2.5 mm model year ’08 vehicles. Given continued soft domestic auto trends, we look for calendar year ’08 GM adds of 2.2 mm representing 50% of the total estimated 4.56 mm OEM additions.

•In-line with FY07E revenue and EBITDA guidance. Our FY07E subscriber estimate of nearly 9.0 mm falls slightly short of XMSR’s previously established guidance range of 9.0- 9.2 mm subscribers. However, we maintain our subscription revenue and adjusting operating loss estimate of $1.02 bn and $200 mm in-line with guidance. Our adjusted loss estimate includes roughly $30 mm of merger related payments in FY07E.

•Estimates Updated for License Rate Increase: We have increased our broadcast royalty payment estimates in-line with the recently announcedcompulsory license rate increase. We now look for FY08E and ‘09E royalty payments to the RIAA equivalent to 9.0% and 9.5% of total revenues, respectively compared to approximately 7.0% of revenue previously.

Free Cash Flow Breakeven Projected in 2011 We have pushed back our stand alone free cash flow breakeven outlook for XMSR to 2011 (from 2010 previously)mainly due to our revised retail subscriber growth estimates. It is important to note, however, that our estimate assumes XMSR will continue to benefit from an expected $1 per month rate increase implemented in 2008E and from further material positive working capital swings through the forecast period resulting from seasonally higher holiday retail demand. Exhibit2 shows the impact to XMSR FCF if no rate increase were implemented as well the impact of excluding the working capital benefit. Rather than increasing rates, we have found that XMSR has begun offering three months of promotional service for subscribers signing up during the holiday selling season. Depending on holiday demand for retail radios, this promotion could limit the typical levels of seasonal working capital related to subscription prepayments.

As highlighted in the past, a monthly rate increase and the impact of working capital are significant variables in measuring free cash flow for the satellite radio operators. Both XMSR and SIRI benefit from seasonal holiday subscription prepayments, which after including a $1 rate increase becomes an evengreater source for near-term liquidity. We currently estimateapproximately $110 mm of positive cash from working capital inFY08E- broadly in-line with our FY07 estimate of $125 mm.

If we were to strip out the $1 rate increase currently assumed for FY08 our FY08E ARPU estimate would fall from $12.38 to $11.66 and full-year FCF breakeven would shift out to 2013. If we were then to exclude the impact of positive working capital,we believe XMSR would not reach FCF breakeven until 2014.

Subscriber Growth Dependent on OEM Channel

Retail satellite radio sales may never build to the levels seen during the “Howard Stern push" during late ’05- early ‘06, but the more important issue is whether the retail channel will ever re-emerge as a viable avenue of growth for the satellite radio industry. We believe XMSR’s quickly maturing OEM channel may be partially responsible for slower retail growth as new car buyers are much more likely to be introduced to satellite radio through initial promotional OEM service agreements rather than the retail channel. XMSR’s two-year head start in the OEM channel relative to competitor SIRI may also explain SIRI’s modestly less severe retail declines.

Industry retail gross additions have decelerated steadily from+51% in ’05 to -20% in ’06 to finally -27% YTD ’07. However, we believe it is still too early to completely rule out the retail channel as a source of growth, as ’06 retail comps against Howard Stern driven sales as well as FCC emission and form factor issues. We believe weaker retail sales trends seen in FY07 may be partially attributable to consumer’s confusion stemming from a mixed marketing message due to the pending merger.

Nevertheless, we do not see any near term catalyst for retail sales and have lowered our near and long-term retail subscriber forecast accordingly. We now anticipate retail gross additions declining 13% YoY in FY08E compared to flat previously.

Our trimmed retail estimates place even greater importance on XMSR’s OEM channel. XMSR actually lost 17K retail subscribers in 3Q07, but added 320K OEM net additions representing more than 100% of the total net additions addedthe quarter. As shown in Exhibit 5, we anticipate the OEM channel adding nearly 100% of XMSR total net additions going forward.

Despite relatively weak domestic auto sales trends, continued OEM penetration gains and more healthy foreign auto partner sales trends have continued to result in strong subscriber growth from the OEM channel. Turning to FY08E specifically, we estimate XMSR will grow its penetration levels on GM models by 1200 bps to 58% and Honda 1000 bps to 57% from FY07 to FY08E. In total, we estimate XMSR will increase its OEM partner vehicle penetration to 30% in FY08E from 20% estimated in FY07E (see Exhibit 17). By YE10E, we expectXMSR to penetrate roughly 40% of its OEM partners’ sales.

Subscriber Mix Shift Could Pressure CPGA Estimates While OEM adds have partially offset the ongoing retail weakness over the last several quarters, its modestly less attractive economics could pressure cost per gross addition (CPGA) as OEM adds become a larger portion of the subscriber base. We estimate XMSR’s largest OEM partner carries a revenue share agreement estimated at approximately 50% in addition to the typical subsidies and commission payments of a typical retail subscriber.

XMSR Remains at Discount to Merger ValueExhibit 6 highlights XMSR’s discount relative to the valuation implied by SIRI’s proposed 4:1 exchange ratio offer. As shown in the exhibit, XMSR has continued to trade at a discount though the spread has generally contracted in- line with incrementally more positive news flow surrounding the merger.

XMSR/ SIRI Merger Potentially Drives Cost Savings and Incremental Subscriber Growth

It is possible that the new proposed service tiers (see Exhibit 7)could help to revive retail subscriber growth trends, but webelieve improved subscriber growth would more likely result from more attractive OEM self-pay conversion rates instead.Improved OEM conversion is especially beneficial in that the additional customers carry 70+% contribution margins with very little incremental CPGA.

Tiered Offering Impact Unknown

We believe proposed programming tiers could potentially benefit subscriber growth by providing a wider array of content at more attractive price points, but its impact to the merged company falls dependent on consumer take-rates of the various offerings. The merged company would continue to offer subscribers their current programming packages at the existing $12.95 price, but would also offer a la carte bundles starting at $6.99 for a 50- channel package. The company would also offer family targeted packages starting at $11.95 as well as 50 channel music and talk specific packages priced at $9.99.

We asses the potential merger value by using three main scenarios:

•Scenario 1: Fixed Cost Savings: Reduction of research and development, and general administrative, and variable content and programming related expenses

•Scenario 2: SAC/ CPGA Savings: Reduction of marketing and retail commission expenses related to competing satellite radio platforms and improved content offerings

•Scenario 3: Incremental Sub Growth: Improved OEM conversion ratios as well as more attractive retail demand

Potential for Overhead Reductions from Merger

We believe the merger of the XMSR and SIRI platforms would likely allow for the reduction of dual G&A, R&D, and variable content and programming expense buckets resulting in roughly $1.4 bn of merger synergies. While larger on-air talent contracts such as Howard Stern would likely have to be renegotiated upwards due to larger listening audiences, we believe the merger would provide more negotiating leverage with the platforms’ condensed programming talent. The current sports (i.e. MLB, NBA, NASCAR) contracts would remain in-place until the contracts reached their expiration dates which are not due for several years.

In addition, we believe the current revenue share agreements with OEM partners would also remain in place given the ever- increasing importance of the OEM channel to subscriber growth. Reductions in R&D channel would likely come only after near term technology needs related to the interoperability of both platforms were addressed.

SAC/ CPGA Reductions Could Result from Merger

We believe the early value produced from a merger would result from reductions in the marketing and commission components of CPGA. Reductions in radio subsidies would likely take longer to emerge as new, interoperable radios would likely be more expensive than the current stand-alone radios and thus require greater subsidies. We believe reductions in commission and promotion expenses would result from increased bargaining power with the retailers and from the more attractive programming lineups of the merged company. It is also important to note that we believe subscriber growth would be unaffected by the company’s more modest marketing campaign.

Incremental Sub Growth Could Result from Improved Conversion Ratios

We believe a XMSR and SIRI merger could drive incremental subscriber growth from both slower retail gross additions declines as well as improved OEM conversion rates. We estimate that retail gross adds would improve approximately 5% annually and that roughly 10- 15% of subscribers who would have typically disconnected service after the promo period decide to stay on. We note that both our retail and OEM estimates could be conservative.

Improved OEM conversion rates are particularly beneficial as they carry significantly higher contribution margins as the initial CPGA has already been incurred. We estimate the improved rates could add approximately 4 mm new OEM subs byYE17E, which would add roughly $4 bn of incremental revenues through the forecast period (’08E- ‘17E).

Tyler Savery position - Long Sirius, Long XM