Stifel analyst Kit Springs issued a report today on SDARS. The report indicates that retail sales were not as good as expected, and that the merger is center stage at this point. The analyst maintains a buy rating on Sirius, a hold on XM, and places merger odds at 55%.
January NPD Data - Retail Overall Slightly WorseThan Expected
January NPD data show weakness in the retail channel, a little worse than expected: Data from the NPD Group,a consulting firm, show Sirius (SIRI, Buy, $2.91) retail sales down 36% and XM Satellite (XMSR, Hold, $12.38) down 46%, compared with down SIRI down 30% and XMSR down 44% in 4Q 2007. The market share split was 66%/34% SIRI/XMSR, versus 68%/32% for SIRI in 4Q 2007. Overall retail sales were down 40% for the month, pacing worse than our expectation of down 34% for 1Q. These numbers give a fairly good guide to the companies retail sales, in our view; however, they do not include the companies direct sales channels, both of which may be gaining market share. The companies have tended to outperform the predictions of the NPD data recently, particularly XMSR.
SIRI and XMSR pacing to miss: SIRI's January result of down 36% for January is slightly worse than our 1Q model(down 30% gross retail). XMSR's decline of 46% for January is slightly worse than our expectation of down 40% on gross retail additions for 1Q. However, both companies have, in the past several months, tended to outperform NPD predictions. Based on the NPD data, and our experience with actual versus NPD predicted results, we would expect SIRI/XMSR to meet our subscriber estimates for the quarter (SIRI with 280k gross retail additions, XMSR with 200kgross retail additions). These results coupled with our churn expectations (1.8% per month for SIRI, 1.85% per monthfor XMSR) would yield about 20k net retail additions for SIRI and a loss of about 50k net retail subscribers for XMSR.
The merger is becoming more important in our view. We may have to continue to bring down stand alone targets if retail woes continue. On a positive note, we believe the DOJ may consider retail market weakness and thus this data point is an incremental positive for allowing the merger.
Retail Channel is becoming less and less important as business model becomes OEM centric: Some might argue weak retail is an indication that consumers aren't interested in satellite radio - certainly this concerns us. However, we would counter that a major reason that retail is weak is that satellite radio is increasingly becoming available in cars. Both companies have seen major ramp-ups in subscriber additions coming from the OEM channel in 2007. It is our thesis that satellite radio will be successful because of high penetration into vehicles. In our opinion the biggest news surrounding satellite radio over the past few months has been Chrysler's, GM and Ford's announcements that they will be installing satellite radio in 65%-70% of its 2008 (Chrysler/GM) or 2009 (F) model year vehicles.
Spread is narrowing: The spread between XMSR and SIRI is now about 7.3%, which has narrowed dramatically over the last month (20% on January 29th), though the spread still implies significant annualized returns (83% assuming an end 1Q close). Though recent comments by FCC Chairman Kevin Martin indicate that a final decision may stretch to March, or even later, though we believe the vast majority of the spread may close on the DOJ decision, which we expect soon. In our opinion, SIRI's 3Q-4Q fundamentals were-are superior to XMSR's. This divergence in performancebetween the two companies introduces another element of downside risk to XMSR shares in the case where the merger is rejected by the DOJ/FCC.
We maintain our approximate 55% probability of a positive outcome at the DOJ and FCC. We believe the DOJ is the critical opinion as we do not believe the FCC will come out against the DOJ. We had been expecting a DOJ decision by now and feel that investors may be taking the delay as a negative indicator. We can see little reason for speculating that the delay is a negative indicator. The annualized return on XMSR, given a positive result, has reduced in recent weeks (see charts below), though still provides large excess returns based on an end 1Q close. We believe this demonstrates a somewhat negative sentiment about merger approval in the market, or investor sentiment that adecision may be further in the future than we are assuming.
Maintain Buy on SIRI, Hold on XMSR: Our $4.00 target price on SIRI is based on a stand-alone value, using 5-year DCF which assumes a 11x terminal multiple of EV/EBITDA and a 9% WACC of, $3.50 and $0.60 of merger option value based on a 55% probability of the merger being approved. We find SIRI more attractive on a stand-alone basis based on its leading retail market share and, more importantly, bigger commitments from its OEM partners and superior fundamentals. At this time, we believe XMSR shares are still enticing from a merger arbitrage standpoint. However, the weak retail trends of XMSR and decent trends for SIRI, continue to lead us to the conclusion that SIRI isthe better risk/reward of the two companies.
Tyler Savery Position - Long Sirius, Long XM