Investor News

Auto sales are down. This has been the month after month news item for most auto manufacturers. With the exception of a few bright spots, the entire auto industry is in a slump. With high gas prices, many companies are offering clearance price on what are now considered gas guzzling trucks and SUV’s. Four cylinder cars are now the hot commodity, and even many of these simply are not selling at the needed pace.

For satellite radio sector watchers, the slumping sales in the OEM channel is an undertone that, coupled with the lack of a merger decision, makes many investors have pause in the sector. In an environment where good news seems to always be followed with a pause and then bad news, it is hard for the satellite radio equities to see any momentum.

The chart below outlines auto sales, SDARS partners and estimated installation rates. We caution readers that this is merely a guide, and not representative of actual installations. Readers who seek more detail can refer to previous months and/or years sales here at Sirius Buzz to draw better comparisons.

Many analysts started off 2008 seeing the OEM channel as a driver for satellite radio subscriptions. Most used some base assumptions projecting subscriber numbers based on a certain level of car sales happening combined with a bigger ramp-up in the rate at which SDARS receivers are installed. Now with half of 2008 gone, and car sales still slumping, there could well be some adjustments in the models that analysts use.

Historically, the take rate for SDARS on OEM installations has hovered in the 50% range. This metric has remained virtually unchanged during the sales slump of cars. For SDARS, that represents a small silver lining, but at the end of the day, installations need to happen, and cars need to sell.

I project that upon a merger decision, additional guidance will be given by Sirius and XM. Until that time, we need to rely on the assumptions of analysts, or our own research into the sector to determine what the subscriber picture will look like at the end of the year.

Position - Long Sirius, XM. No Position OEM’s.

With automobile sales hitting record lows, satellite radio sector watchers have more than just the merger to worry about. Satellite radios installed into cars is where SDARS gets the most exposure. Consumers have been pretty consistent on opting to become subscribers at about a 50% clip, but prolonged weakness in the OEM channel is now offsetting the higher installation rate. Less exposure translates to fewer subscribers.

The merger is still the big news in the sector, but weak subscriber numbers is an undertone that has many trying to figure out what to establish as a value for these stocks in both the near as well as the longer term.

We will soon publish the June auto sales data as we do each month, but the news is already on the street. Cars are not selling, and that represents yet another question mark on satellite radio equities.

Position - Long Sirius, Long XM

On the heels of Sirius Satellite Radio issuing post merger guidance, and a sharp decline in price after the Goldman Sachs analysis, Merrill Lynch analyst Glen Campbell has raised their rating to BUY with a PO of $2.70 per share, a 20% discount from their YE09 DCF value of $3.42/share.

The analysts cautions the short term on weak OEM and subscriber numbers, but feels that these issues carry only a minor impact on long term values. Also noted by the analyst was the fact that the guidance issued by Sirius is more bullish than their own, but that the issue seems to center on timing of synergies.

Merrill Lynch sees merger approval happening in the near term.

Position - Long Sirius, XM.

Despite finally getting some merger guidance for satellite radio, the stocks responded by giving up virtually all gains acquired late in the day Friday. Sirius and XM gave the first real glimpses of synergies in a press release issued Monday morning. The new guidance includes:

• Expects 2009 Total Net Synergies of $400 Million
• Expects 2009 Adjusted EBITDA of $300 Million
• Expects Positive Free Cash Flow, before Satellite Capital Expenditures, for 2009

Sirius was clear that the synergies outlined assume that the proposed merger with XM passes regulatory muster. The DOJ approved the deal some time ago, and a Draft Order has been circulated by FCC Chairman Kevin Martin. While the new details did not get very specific, the company did offer a bit of added flavor:

• Total synergies, net of the costs to achieve such synergies, for the combined company are expected to be approximately $400 million in 2009;
• Adjusted EBITDA for the combined company is expected to be approximately $300 million in 2009. Adjusted EBITDA is net income/(loss) before interest and investment income, interest expense (net of amounts capitalized), depreciation expense, and non-cash stock compensation expense; and
• The combined company is expected to achieve positive free cash flow, before satellite capital expenditures, for the full year 2009.

“The upside potential from this merger is significant. In addition, the synergies, adjusted EBITDA and free cash flow are expected to continue to grow in subsequent years, and we look forward to providing more detail of this growth in coming months,” said Mel Karmazin, SIRIUS Chief Executive Officer and the previously announced CEO of the combined SIRIUS and XM.

While the new information is welcomed news, the pending merger is what people are really interested in. This new guidance should give analysts some new items to consider as they begin to draw up their models.

Position - Long Sirius, XM.

After a virtual drubbing over the past couple of weeks, the satellite radio stocks of Sirius and XM saw a boost today that gave investors a bit of a break, and perhaps even set the tone for a good weekend.

The natural question happening at this point is why did this sharp upturn happen? As with anything there can be many answers and theories. Theories from FCC votes being leaked to shorts covering for the weekend, to market manipulation are all ideas that people seem to love to discuss.

Personally, I look at the upturn in both Sirius and XM and see something interesting. Sirius was up more than XM. Thus, the arbitrage spread actually got larger in the last couple of hours of the day. This activity could give legs to the theory that shorts are covering. One popular arb play if you felt the merger would pass was to go long XM and short SIRI.

I also consider the fact that the Draft Order has been issued, and that there is speculation that we could begin to know commissioner stances by mid next week.

Combine these two theories, and it is possible that we are onto something. How much upside this can deliver is yet to be seen, but Monday will be a day that investors in the sector may want to pay attention.

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XM Satellite Radio has been busy over the past day or so. The company announced that they have extended their deal with Chairman Gary Parsons, borrowed $100 Million, and will commence an exchange on their 1.75% convertible notes due 2009.

PARSONS

Gary Parsons, the Chairman of the Board, reached an agreement with XM through November of 2009. His contract was set to expire June 30th of this year. The deal remains identical to where it was in the past in terms of salary and bonuses.

$100 MILLION BORROWED

XM announced that they have borrowed $100 Million from USB AG. A portion of the funds will be used to pay down a draw on the GM credit facility. This action gives XM Satellite Radio full access to their $150 Million credit facility. This improves the cash situation, but adds to debt. One concern the street has had was the ability to obtain financing if needed.

EXCHANGE ON 1.75% CONVERTIBLES

XM has reached agreement with 94.6% of its $400 million aggregate principal amount of 1.75% Senior Convertible Notes due 2009. XM will commence the exchange at some point before to July 10th. The interest rate on the new notes is 10% and will begin to accrue on July 2nd. Terms are said to contain substantially the same terms as the existing notes. Additionally, the noteholders have agreed that the proposed merger of XM with a subsidiary of Sirius Satellite Radio does not constitute a “Fundamental Change” under existing terms, and that the exchange offer will have a condition of the closing of the merger.

Position - Long Sirius, Long XM

The National Association of Broadcasters announced recently that they appear to have the votes needed to see their side of the terrestrial radio royalty issue pass through the House of Representatives. The NAB announced that four additional House members have voiced opposition to the recording industry-backed effort to have royalties for music played on local radio stations. According to the NAB, the Congressional opposition to the label-led campaign now stands at 219 out of the 435-member U.S. House of Representatives. This would give the NAB side of the issue a majority.

NAB Executive Vice President Dennis Wharton stated, “Today’s announcement sends a powerful message to foreign-owned record labels that Congress is not falling for their bogus campaign to blame local radio stations for their financial woes. NAB thanks those members of Congress who appreciate the fact that free radio airplay of music generates untold millions into the wallets of performers and record labels. We will continue to educate policymakers on the devastating impact this RIAA tax would have on America’s hometown radio stations.”

Opposing the proposed royalty legislation has been one of several lobbying efforts on the part of the terrestrial radio organization. With what appears to be enough support in the House, the lobbying efforts could well shift over to the Senate. Terrestrial radio, unlike satellite and Internet radio, currently does not have to pay royalties.

NAB Press Release

With Sirius and XM at long term lows, the natural question is, “where is the bottom?”

The answer to that question can take many forms, but something we need to consider is how it is that we got to where we are now.

1. The merger process has taken quite a long time, and the uncertainty associated with the long wait has caused the equities to suffer, and the confidence of investors to erode.

2. The Wienkes analysis (Goldman Sachs) set a low target for Sirius and XM, and the street reacted by selling off in a substantial manner.

Wienkes carries a “Convicted Sell” on Sirius, This is the lowest rating that is offered by the firm. When Wienkes issued his note, he set a $1.00 price target on Sirius as a stand alone company, and a $1.75 target as a merged company.

Most seem to feel that the merger will pass through the FCC process, so what we are dealing with is the $1.75 price target. Sirius is very close to that target right now. So close in fact that we should hear from Wienkes soon. The question is what his opinion will be.

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Well, it is now official and in black and white. The FCC updated their “items In Circulation” list today and the proposed merger of Sirius and XM is on the list. The Draft Order circulation happened on June 17th.

At this point, the commissioners all consider the draft order and make their voting determinations. Watch for possible announcements about voting intentions over the coming two weeks, although commissioners do not always give an indication of their voting intentions.

With the Draft Order officially issued, an answer on the proposed merger is within reach.

FCC Items In Circulation List

Position - Long Sirius, Long XM

In a note issued today, Cowen analyst Tom Watts was very pointed in his disagreement with Goldman’s Wienkes.

“We Disagree With Competitor’s Negative View,” noted Watts. He also stated that investors could, “Expect a Rebound.”

“Yesterday, Outperform-rated SIRI ($2.13) traded down 13% and XMSR 18% ($8.61). A competitor’s note (with which we disagree) contributed and technicals may have widened the arb spread. We expect FCC approval and the debt restructuring to drive a rebound of both stocks in the near term.”

Watts cited several factors including increased OEM installations (penetration rate) would offset slowing car sales, substantial merger synergies of $5 billion, FCC approval in July, the debt issue being closed not as big a hurdle as some anticipate, and the arb spread to begin to narrow again as anticipated merger closure draws near.

While watts did not take on specific aspects of the Goldman report, some obvious factors that I note are that Goldman states that “young people” are buying MP3’s. This is not real news. The “young people” have not been the largest contributor to SDARS subscriber-ship since the beginning. Additionally, the A-La-Carte pricing may make subscriber-ship something that is more budget friendly to the younger crowd. Combine MP3 capability with the “music discovery” allowed by satellite radio, and there could be a winning combination. The MP3 crowd is often music centered. A satellite radio service at $6.99 per month that enables fans to get only what they want may well carry more appeal.

Additionally, Goldman cited that ARPU would be impacted with the new pricing plans, and mentioned an OEM take rate of 50%. What it would appear Wienkes did not consider was that more attractive pricing points may increase subscriber-ship, thereby offsetting a lower ARPU (oversimplified example):

CURRENT TAKE RATE 50%

100,000 cars turn into 50,000 subscribers paying $12.95. 50,000*12.95 = 647,500 - ARPU of $12.95

TAKE RATE OF 50% Full Price, and 10% AT $6.99

100,000 cars turn into 50,000 @ $12.95 and 10,000 @ 6.99. 50,000*12.95 + 10,000*$6.99= $717,400 - ARPU of $11.96

While the ARPU is indeed almost $1 lower, the revenue coming in the door has increased. The ability to capture additional subscribers at the lower price point represents more dollars. ARPU is an average metric of revenue per subscriber. Simply stated, the business model will shift a bit more towards volume, something that it appears Goldman’s analyst has not fully considered.

With no company guidance, and no real certainty it becomes hard to know what analysis to count on. There simply is nothing for anyone to hang their hat on. Goldman is the “golden child” of the moment, but how long will that last. SDARS is quickly approaching a level where Wienkes will need to come out with yet another opinion. Will he “upgrade” from “convicted sell” to “sell”, or adjust his target further down? Only time will tell.

Position - Long Sirius , Long XM