Jim Cramer recently indicated that he feels that Sirius and XM should claim a failing company argument in an effort to gain approval from the FCC for their proposed merger. According to Cramer, XM Satellite Radio is the company in more dire straights than Sirius, but is citing the faining company argument really the path to merger completion?

The first thing we need to consider is what exactly the FCC is making a decision on. The FCC is deciding about the public interest in the merger. Will the public be better served if the merger is allowed, or if it isn’t. Part of that review centers on the financial viability of the companies even if they themselves do not make the claim.

According to Cramer, Sirius and XM could argue that if one company fails, we will be left with a single satellite radio operator anyway. In the most simplistic terms this may be true, but functionally, it is unlikely. If one of these companies were to be failing, they would have to expend all efforts to make the company survive. This would include dilution as well as additional debt. The stock would take a hit, and the valuation of the company would drop. It is possible that it could drop to a point where another buyer steps in, and thus we would still have two satellite radio companies.

Let’s not forget that the companies are now on two week cycles regarding their merger deal. This means that either company could walk away without penalty at virtually any time. That would free them to pursue other deals if they desire. Would a Primosphere, a CBS, or a Google have interest in one of the companies? Perhaps, but perhaps not. If the company can be had at an attractive enough price, a buyer could step into the picture. However, seeing the financial performance of the companies to date on a stand alone basis, any buyer would be assuming a lot of risk.

Sirius and XM need to be financially viable. They need the merger to bring the finances of this business in line with what the street and investors feel will deliver value. The best chance for that happening is through a merger. To claim financial hardship as a reason for the merger would carry extreme damages to the sector as a whole. It could conceivably apply enough pressure to get the deal done, but the cost would be more extreme than either company, or the merged company can risk.

The merger has debt that needs to be refinanced. If a standalone argues that it is failing, will a lender feel that the merged company is indeed strong enough to make it all work? A failing company argument will put control of the merger in the hands of the lenders who are need to finance portions of the deal. To give up this level of control should in my opinion be a last ditch effort.

Given the information that a draft order is about to be circulated (it is my opinion that this will happen by Wednesday of next week), these companies should hold off on any drastic measures. The logical person understands that the arrival at a draft order means that Sirius and XM will have come to some sort of terms with the FCC. In my opinion, prior to a draft order from the FCC, we will see a publication outlining some of the specific concessions that Sirius and XM voluntarily arrived at. Not all concessions that have been discussed are the type that the FCC has the power to mandate. Thus, the companies likely must outline their voluntary concessions in writing to the FCC. Once this documentation is in hand, we will see a draft order published. From that point, a decision is all that we will be waiting for.

Arguing a failed company at this point would throw this merger into a tizzy, and the street would likely punish that course of action. I can not picture Sirius and XM taking that step given the current position the merger is in at the FCC.

The best case scenario is for Sirius and XM to gain approval from the standpoint they began this process with. The best situation is to get the FCC to focus on more public interest and less on regulation.

The street is already battle fatigued. A failed company presentation would make things even worse. I do see some logic in what Cramer says, but feel the cost is high.

Position – Long Sirius, Long XM