Morgan Stanley analyst Benjamin Swinburne issued a report on Sirius today in which he reduces the estimates in both the retail as well as the OEM channel. The analyst also reduced 2008 revenue estimates.


Sirius Satellite Radio - Reducing Estimates at Both Retail and OEM Channels

What's Changed

2008E Revenue From $1.31 bn to $1.22 bn
2008 OEM Net Adds From 1.43 mm to 1.37 mm

Reducing Subscriber Growth Outlook: We are reducing our subscriber growth outlook for SIRI in 2008, based on continued retail weakness and a slowing domestic automotive market. We have pushed back our assumed rate increase from ’08 to ’09 on our SIRI standalone model, and expect SIRI could reach FCF (CFFO less capex) breakeven by 2009 under that scenario. The funded status of SIRI to reach that breakeven point is largely a function of continued cash from working capital changes (specifically from pre-paid subscriptions).

Lowering OEM Gross Additions: We have reduced our FY08E gross and net addition estimates by 430K and 65K, respectively, due to our lowered expectations for Daimler Chrysler and Ford. In line with ongoing weakness from the domestic auto manufacturers, we have reduced our estimates for Chrysler and Ford by roughly 200K and 230K, respectively. At the end of FY08E, we look for 22% SIRI penetration - down from 24% previously.

Retail Gross Adds Unchanged: We have kept our FY08E retail gross and net addition estimates broadly unchanged from our previous forecast. We look for a 15% decline in gross additions during the year and roughly 300K net additions.

Later Satellite Launches Ease ’08 Capex: We have pushed by our assumptions for the launch of FM-5 and FM-6 to ’09 and ’12 compared to ’08 and ’10 previously. Accordingly, we have reduced our FY08E capex estimate from $280 mm to $160 mm, but have increased our FY09E capex estimate from $160 mm to $190 mm

In OEM We Trust We look for approximately 300K retail net additions in FY08E, representing a nearly 50% decline YoY. We currently assume SIRI will end FY08E with 9.997 mm subscribers. Heading into ’10-‘12E, we believe the retail channel could actually begin to lose net subscribers - signaling that subscriber growth for SIRI will rest solely on the OEM channel. With OEM factory build-in rates quickly ramping and an abundance of in-home media choices,we believe satellite radio listening is likely to become an in-car listening experience. Quickly ramping OEM partner penetration rates should benefit SIRI sales; however, lingering domestic auto weakness could weigh on its benefit as penetration rates increase.

We remain concerned with the possibility of both SIRI and XMSR FCF breakeven. While both companies have recorded positive 4Q06 and likely 4Q07, neither has yet to generate annual FCF. Our current estimates imply that SIRI will reach FCF(CFFO less capex) breakeven in 2009E; however, our estimates include the benefit of a $2 rate increase implemented in FY09E. This is a key assumption that remains in question given the regulatory scrutiny over its pricing practices. As, shown in Exhibit 2, should SIRI not implement a rate increase this year, FCF breakeven would not arrive until 2013.

What’s Changed We have made the following changes to our FY08E SIRI outlook:

•We have increased our FY08E adjusted EBITDA loss expectation approximately $42 mm to $197 mm from $155 mm, previously. Our revised outlook stems from our raised SAC, reduced subscriber and revenue growth expectations for the year. Our revisions have lowered our FY08E pre-marketing margin expectations approximately 200 bps from 35% to 33%.

•We have lowered our YE08E subscriber outlook by roughly 150K from 10.15 mm to 10.0 mm. We have lowered our OEM net addition estimate from 1.43 mm to 1.37 mm and have kept our retail net adds estimate of 300K broadly unchanged from our previous forecast. While lowering our subscriber outlook, we have lowered our monthly churn expectation to 2.55%compared to 2.90% previously.

•We have increased our FY08E SAC outlook from $82to $95 due our revised subscriber mix assumption for the year. We expect the OEM channel, which carries incrementally less attractive economics, to account for greater than 80% of full-year net additions.

•We have lowered our FY08E capex estimate from $280 mm to $160 mm as we have pushed back our assumptions for the launch of the FM-5 satellite. We now assume FM-5 will launch in 1H09 compared to our previous 4Q08 expectation.

4Q07 SIRI Results vs Morgan Stanley Estimates SIRI reported mixed 4Q07 results marked by weaker than anticipated ARPU and pre-marketing EBITDA margins, but in-line churn. The increased impact of subscriber mail-in rebates in the quarter led to fully loaded ARPU of $10.05coming in $0.49 below our estimate. Pre-marketing EBITDA of $52.8 mm came in below our $79.1 mm estimate, implying a 21% margin compared to our 30% expectation for the quarter.

However, roughly $15 mm of the pre-marketing EBITDA shortfall came from catch-up payments related to the increased performance rights royalty license. Excluding the incremental CRB payments, the 4Q07 pre-marketing EBITDA would have been approximately $68 mm.

4Q07 revenue and adjusted EBITDA loss came in at $249.8 mm and $107.2 mm compared to our $263.7 mm and $100.8 mm, respectively. Reported churn of 2.3% came in in-line with our estimate, while 4Q SAC of $90 came in $2 below our estimate, or down 13% from 4Q06. Lower SAC was likely attributed to fewer retail subsidies and commissions due to a higher OEM sub mix in the quarter. SIRI pre-reported 4Q07 subscriber results which showed weak retail growth leading to YE07 subscribers coming in short of our 8.41 mm by roughly 90K. Retail gross additions declined approximately 42% YoY compared to -25% in 4Q06.

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 standalone 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 by YE17E, which would add roughly $4 bn of incremental revenues through the forecast period (’08E- ‘17E).

Position - Long Sirius, XM