Stifel Nicolaus Analyst Kit Springs issued a report on Sirius and XM this morning. The detailed report goes into several aspects of the merger, financial analysis, subscriber metrics, etc. Springs joins a list of analysts that are projecting negative net retail additions for XM, something that investors should be aware of prior to the quarterly meeting. Spring attributes XM's retail woes in part to merger confusion and a lack of new hardware available to consumers. Spring states that the business model is fine as long as OEM penetration is still ramping up. Springs sees merger odds at greater than 55%, and feels that the market has only priced in the merger at 30%. According to Springs this presents upside opportunity.
3Q Sat-Rad Preview - Retail Weakness; but Merger Risk Reward Still Attractive
Risk / return on merger is still quite attractive, in our view: We attribute the recent ~25% run up in SIRI and ~35% run up in XMSR shares to increased confidence in merger approval based in large part on approval of Whole Foods/Wild Oats decision and perhaps the success of the iPhone. Despite the run, we believe the current 11% spread (~32% annualized return by late December) implies the merger is unlikely to go through (perhaps 30% odds according to spread). We continue to see a 55%+ probability of merger approval, providing for disproportionate upside potential for both stocks. We expect to hear from the DOJ within the 30-45 days and believe the FCC is likely to later side with the DOJ.
Fundamentals have weakened in 3Q in retail and due to overall OEM sales (though we still see increasing OEM penetration): Retail sales in July and August were down more than expected, particularly for XM. Our cursory survey of Best Buy and Circuit City salespeople suggest that the consumer confusion around the merger is affecting sales, though we believe lack of product innovation is the bigger reason. As a result of weak retail share, we are lowering our XMSR's 2007 subscribers to the low end of guidance (from mid) and keeping SIRI estimates unchanged. While this increases fundamental risk, it also increases likelihood of merger approval, in our opinion. The OEM channel could be modestly affected in 3Q by a 5-8% decline in industry sales, though we are confident that penetration levels are continuing to ramp-up, as evidenced by Chrysler's recent commitment to equip 70% of its model year 2008 fleet. XM Chairman Gary Parson was recently upbeat regarding churn levels and OEM installation rates, offset by admission of retail weakness.
We find SIRI (Buy, $3.42) a better risk/reward on a stand-alone basis, mainly due to higher commitment levels to satellite by its OEM partners. We are maintaining our $17 target price on XMSR (Buy, $14.00) based on a 5-year DCF value of $13.50, plus $3.50 merger option and $4.75 target on SIRI based on a stand-alone DCF.
Price changes since merger announcement shows little value has been priced in: SIRI is down 8% and XMSR is up flat since the proposed merger announcement, versus the S&P up 4.8%. We have seen only limited data points that change our outlook on a stand-alone basis - weakness in retail offset by increasing ramp-up in the OEM channel. Our target prices remain $4.75 for SIRI (based on a 5-year DCF or 16x 2012 FCF discounted at 10%) and $17 for XMSR, based on a 5-year DCF, which assumes a 9.7x terminal multiple EV/unlevered FCF and a 9.4% WACC, plus option value of a merger of $3.50. We estimate a merger completion in which XMSR received 58% of the $4.8B of merger synergies would result in a $21 target price, all else being equal. It is our belief that the Street is still pricing in only a modest amount of the merger synergies calculated for the combined company. It is our belief that the probability of the merger is 55%+ vs. 30% priced into the stocks.
Tyler Savery Position - Long Sirius, Long XM