According to Barron's Online on July 1, 2008, 11:20 am, Merrill Lynch’s Glen Campbell this morning raised his rating on Sirius Satellite Radio (SIRI) to Buy from Hold, while slightly trimming his price target to $2.70 from $2.80. Campbell says he expect “imminent approval” from the FCC for its pending merger with XM Satellite Radio (XMSR). Campbell says the upgrade reflects the recent decline in the stock and the upbeat post-merger guidance the company provided yesterday. The company sees $400 million in merger synergies, positive free cash flow before satellite cap ex and $300 million in EBITDA before stock compensation.
Campbell contends the current valuation discounts 30 million subscribers in 2017, which would be about 1 million new subs a year after 2009. He thinks that may be too low, noting that satellite radio should become more appealing and affordable post merger with tiered and a la carte pricing.
Now I summarize from Mike Stathis's Article on Seeking Alpha entitled, "Satellite Radio Faces Enormous Challenges".
Who will benefit from SIRI Upgrade?
Mike wrote, "Wallstreet profits, not you. Now do you think Wall Street analysts would bother telling you all of this? Of course not. If they did, they would not get any banking business from SIRI and XMSR. As well, they aren’t going to tell you that the airlines industry is one of the worst to invest in for the same reason; not just now, but it has been one of the worst for decades. Think about it. You have a saturated market whose health is determined by gas prices and can easily be hammered with a wave of terrorist attacks. As well, the airlines have unreasonable unions, generally terrible corporate culture, and the security of management knowing they will get a government bailout if needed. Most airlines do not even own their planes. They lease them. As a result, they do not build equity. All they are doing is churning through cash and debt to survive the next day. Wall Street won’t ever tell you that this industry displays one of the poorest sets of business fundamentals because it is also an industry that needs a lot of banking business."
Mike described Satellite Radio's future by comparing this industry with wireless phone industry. He wrote, "A good analogy would be the wireless phone industry. Ten years ago, there were several wireless providers; however, as competition heated up, each player had to fight more for revenues. As a non-combative way to expand revenues, the industry came up with “bells and whistles” – you know new sources of revenue – ring tones, texting, network plans, family plans, etc. This helped delay some of the competitive effects due to market saturation, but these tactics were only temporary. After running out of new ways to generate increasing revenues along with price wars, we now see a heated battle with only a few big players remaining. Today there really only are four big players and a couple of small ones. As we know, the future of Sprint (S) and T-Mobile (DT) are questionable. Each stands a good chance of being acquired over the next few years".
But Mike commented there is huge different to comparing between satellite radio and internet industry. He wrote, "Comparing the wireless and Internet industry growth models to satellite radio, we see that even with very little competition, satellite radio has struggled from day one. What does that say? First, there is a big issue with market penetration and market size. It is clear that satellite radio’s biggest barrier has, and will continue to be, market acceptance and market size for a variety of reasons. New entrants have not entered this market because the growth has been relatively slow and/or the overall market potential is not viewed as large enough to support additional entrants. The wireless phone market was much different. Consumers were bending over backwards to sign up for cell phone contracts. This led to the growth of several regional providers. In contrast, satellite radio providers have gone to U.S. auto manufacturers and struck deals to give buyers a limited time of free service. While consumers were lining up for wireless service, satellite radio is knocking on doors. And that, is a huge difference".
"Since this industry is regulated, there was a certain level of risk that was not under the control of the radio satellite industry from day one. Many of you are now realizing this as SIRI and XMSR struggle for approval by the FCC to merge. As many have pointed out, the NAB has strong ties with the FCC. Consequently, even if the merger is approved, the combined firm will continue to face additional regulatory risks down the road. These are risks that should have been factored into the initial investment due diligence".
"As a way to help drive subscribers, satellite radio providers (SIRI and XMSR) have continued to drop monthly rates, now at $10 to $13 per month. They have even tried to mimic the wireless industries “family plans” by adding each additional line (vehicle) for $7 a month. The bottom line is that the management in this industry is neither financially nor strategically savvy. They need to innovate better ways to drive revenues that optimize the unique attributes of their service instead of following the marketing tactics of the wireless industry. One of the biggest weaknesses of satellite radio is that revenues will be limited to the $10/month (assuming you sign a year contract). I would estimate that until SIRI reaches 30 million subscribers, margins will continue to suffer (margins would be better with a combined XM-SIRI firm). Given the high fixed costs and overly generous payouts to executives and Stern, SIRI needs a certain threshold of subscribers before it can realize an economy of scale sufficient to help fuel future earnings’ growth. The problem is that this threshold (perhaps 40 million) approaches market saturation (50-60 million) in my view. Therefore, the short-term issue is cost containment while the long-term issue is market growth or anything else that might increase earnings growth. The only way to increase market penetration beyond the saturation point is by bundling services so that the market resembles the larger mainstream size. This is something only large media players can do".
"Even if the combined entity reaches 50 million, subscriber growth would decline thereafter as market saturation is approached. As a result, the industry would be faced with declining earnings growth. In addition, we all know what that means. Even a combined XM-SIRI would need to create “bells and whistles” to boost revenues since it would have limited resources to expand the market. However, the satellite model does not permit this. It is a fixed revenue model that is highly dependent on market growth and limited by the total number of subscribers".
"One of the first rules of acquisitions is that you should never merge two firms that are struggling. Some feel that this strategy will capture cost savings resulting in improved margins. However, if the core business of each is not sound, all you will create is a larger piece of junk. One of the more recent examples of this was the Sears/K-Mart merger a few years ago. From the beginning, it was clear to me that this would not work. This was an act of desperation that will only end up delaying the inevitable liquidation of assets. While an XM-SIRI merger will most likely provide more synergy and cost control, even if we look past the challenging issues of market penetration and limited revenue growth per subscriber, competitive threats will be very difficult to overcome."
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