RBC Issues Note on XMSR

With the stock prices moving upwards, and merger sentiment improving, RBC’s David Bank takes a bit of a contrarian view in a report issued today relating to XMSR, stating that the merger benefits are now priced into XM’s stock. The theory is interesting given the bump Sirius and XM have seen in thae past couple of days on merger speculation.

Report Excerpts:

RBC Capital Markets – David Bank

RBC/XMSR: Time to Take Money Off the Table

Even With Regulatory Outcome Looking More Positive, Benefits Of Merger Are Now Reflected In Current Valuation

Investment Opinion

Time To Take Money Off The Table. With shares of XMSR now above our $14 price target, we are lowering our rating to SP from OP. We continue to believe probability of merger approval are greater than 50% and merger should generate significant cost synergies. While we see potential upside to $16 should regulatory approval be met and all potential synergies be realized, this is balanced against remaining regulatory risk, and fundamental challenges ahead such as anemic retail demand and upcoming resolution of RIAA arbitration.

Probability Weighted Value of Merger Now Baked into Shares. Our $14 price target assumes a $10 intrinsic value for XMSR and $6 of synergies from the merger, discounted to >50% closure probability. We believe the market is appropriately valuing expected synergies as well as approval probability, partially reflected in current 9.6% arb spread, the lowest in several months. As such, we’d move to sidelines.

DOJ Ruling Could Come In Next 30-60 Days. Filings indicate XM/SIRI ($3.46; Sector Perform; Speculative Risk) are now in substantial compliance with DOJ ‘s request for additional information. Typically, DOJ begins clock culminating in final approval/disapproval of transactions under review once parties have complied with requests for additional information. While its possible for DOJ to “stop the clock”, our sources indicate odds don’t favor DOJ pushing for prolonged extension. Basically, its time to “make a decision”.

Other More Fundamental Risks Exist. Aside from merger implementation risk, we’d highlight the risk in anemic retail demand and the uncertainty surrounding the RIAA arbitration outcome. Given what we see as a strong ramp in the OEM channel which will mitigate some of the retail softness, we’d place more significance on the latter of the two.

July NPD Data Slightly Worse Than Our 3Q Expectations. July NPD reflected at 38%/62% XM/SIRI share respectively vs. our 41%/59% 3Q expectation. NPD reported a 32% July decline for XM vs. our 12% expectation in 3Q. We’d note that NPD reported a 27% decline in XM retail gross adds in 2Q, vs. the 21% decline that XM actually reported (we believe this is largely attributable to the omission of Wal-Mart from NPD data). Still, early indications are that there could be downside to our gross retail estimates.

We use a triangulated valuation methodology combined with probability/time weighted merger synergy value to derive our $14 price target for XM Satellite Radio. We average our DCF analysis and our 1 year forward discounted multiples on 2013E EBITDA and FCF, 2013 is when we believe that XM will reach maturity. We use a 10x EBITDA multiple and a 12x FCF multiple as these represent the approximate multiples for terrestrial broadcasters based on 2007 estimates. We add XM’s present value of NOLs to our 12x 2013E FCF to derive our FCF multiple valuation. We then add our estimated synergy value of a merger with Sirius and apply a probability of >50%. After discounting back for expected time to close, we add to our $10 standalone value to arrive at our $14 price target. If subscriber growth slows, and Satellite Radio is more of a niche product than a mainstream product, our price target could be too aggressive. In addition, if XM is unable to reduce its costs per gross addition, it may not reach profitability as expected, putting our price target at risk. Furthermore, a definitive or otherwise partial rejection of XM’s attempt to merge with Sirius would put our price target at risk.

Tyler Savery Position – Long Sirius, Long XM