Jeff Wlodarczak, analyst for Wachovia published a report on XM's Q4 and 2007 Operating Results.


XM Satellite Radio Holdings Inc.

XMSR: Weak Satellite Radio Demand Trends Continue in Q4

• XM Q4 RESULTS - WEAK SUBSCRIBER (SUB) TRENDS CONTINUE--XM reported a 4% YoY increase in net new sub additions to +460K (from +443K in Q4 ’06), materially below consensus +522K expectations although in-line with out 450K est. Partly reflecting a lack of interest in the sat radio product, the aftermarket & data channel added only +99K (-64% YoY) net subscribers. Gross sub additions were 1.13M (+6%) below consensus at 1.198M and in-line with our1.119M. Churn (excluding promotional disconnects) was 1.72% compared to our forecast of 1.80% and total churn was 2.52% compared to consensus of 2.6% and our estimate of 2.5%. The OEM conversion rate remained stubbornly at the 50% level although it did improve to 53.9% (vs. 52.4% in Q4 ‘06 and 52.5% in Q3 ’07), we believe this modest improvement reflected extremely aggressive post trial promotional activity.

• FINANCIAL RESULTS MIXED--All-in subscriber monthly ARPU for Q4 was $10.10 in line with $10.00 consensus and our $10.01 driving reported revenue of $308M roughly in-line with our estimate of $306M and consensus of $304M. Cost Per Gross Addition (CPGA) was $120 ($140 as XM defines it) vs. our expectation of $127 and $116 in Q3’07 and $128 in Q4’06. CPGA excluding promotional discounts was $156 (vs. our estimate of $162). Operating cash flow was a loss of ($155M) (including stock option expense and merger related expense) versus our ($137M) loss. The difference between our loss and actual results was related to higher than expected stock-based comp. Like SIRI ($2.93), XMSR did not provide 2008 guidance.

• BOTTOM LINE: Weak demand trends, highlighted by continued very weak retail demand and 50% OEM conversion rates continue (despite aggressive post trial promotional activity). While we believe there is clearly a material niche for sat radio service, we think both players need to ''right size'' their cost/business models and a merger of the two players makes a lot of sense to speed this process up. The problem is merger approval (previously expected by the end of 2007) is still uncertain, with the stocks in our opinion overvalued as standalone entities and at best fairly valued as a combined entity. We estimate the industry’s current enterprise value implies the industry will reach the 31M subscriber level (assuming post merger a subscriber is worth $350 in a steady state), vs. the YE 2007 (which includes a material percentage of “subscribers” that are inactive on dealer lots and in promotional periods).

Valuation Range: $10 to $13 Our valuation range is based on a discounted cash flow. We assume a discount rate of12% and a terminal value of 60x estimated 2010 free cash flow. Risks include slower-than-expected subscriber growth and competing terrestrial alternatives.

Investment Thesis: XM has over 8 million subscribers, strong OEM relationships and impressive technology. We are cautious on the outlook for satellite radio and XM and are concerned about the aggressive growth expectations implied by the market value.

Tyler Savery Position - Long Sirius, Long XM