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The announced merger of the two radio companies was greeted with optimism, but analysts caution that hurdles will hamper profitability
The initial response to the planned $13 billion merger of Sirius Satellite Radio and XM Satellite Radio Holdings was characterized by hurrahs and what-took-you-so-longs. Shares of both companies rallied on optimism that the transaction will result in lower costs and put the merged entity on a faster road to profitability. The new company "will be better positioned to compete effectively with the continually expanding array of entertainment alternatives," said XM Chairman Gary Parsons and XM Chief Executive Hugh Panero in a statement.
But a host of analysts say the fanfare may be premature. One big hurdle for Parsons, Panero, and Sirius CEO Mel Karmazin is winning the go-ahead from government regulators at the JusticeDept. and Federal Communications Commission (see BusinessWeek.com, 2/20/07, "The XM-Sirius Deal May Not Fly").
As Sirius (SIRI) and XM (XMSR) focus on gaining regulatory approval, a multitude of rivals—from terrestrial radio stations to consumer electronics and online music vendors such as Apple (AAPL)—will waste no time wooing customers. Researchers at IDC had expected the satellite radio companies to reach a combined 22 million subscribers by the end of 2007, but XM and Sirius may now miss that target, "given the uncertainty around the merger and availability of service on an ongoing basis," says Susan Kevorkian, an analyst with IDC. The companies ended 2006 with 13.6 million subscribers, falling short of the 15.5 million expected by IDC (see BusinessWeek.com, 2/16/07, "Analyst to XM, Sirius: Quick Quibbling").
Why the slowdown? Would-be subscribers are likely to fret that if the merger is approved, former rivals will have less incentive to keep prices low and instead raise subscription fees. The new company could raise prices by 5% to 7% a year, much like the cable industry, says Tuna Amobi, an analyst at Standard & Poor's, which like BusinessWeek, is owned by the McGraw-Hill Cos. (MHP). To be sure, some satellite radio users have said on various online forums that they wouldn't mind paying more for access to a richer lineup of channels. Today, XM offers more than 170 channels, while Sirius carries 130. There's some overlap, and it's not clear which channels will make the final cut. Indeed company executives say they'll trim expenses in part by reducing redundant programming—part of the cost savings aimed at keeping subscription fees low.
But analysts' concerns don't end with subscription fees. Automakers that had been installing satellite radios in cars may hold off installing new XM and Sirius equipment in additional car models until it's clear which company's model of radio receiver prevails—or until a hybrid is developed. Adding to the uncertainty is the possibility that, should the merger fall apart, XM or Sirius would become acquisition targets for one of the satellite television companies, EchoStar Communications (DISH) or DirecTV (DTV). That gives carmakers added leeway to make cars iPod-friendly, rather than satellite radio-equipped, letting users stream downloaded music through a car's speakers.
Eyes Off the Prize
More important, XM and Sirius could see a subscriber slowdown as they put resources into making the merger happen instead of attracting new users. "If both companies are focusing on making the merger happen, it's likely to take attention away from subscriber acquisition," Kevorkian says.
Any loss of focus couldn't come at a worse time, as some of XM's and Sirius' rivals ramp up marketing. Terrestrial radio stations are spending hundreds of millions of dollars to promote high-definition radio, allowing consumers to listen to free, high-quality programming by buying special radio receivers. Wireless technology powerhouse Qualcomm (QCOM) is about to launch its MediaFlo service for Verizon Wireless and Cingular/AT&T (T) customers.
The launch is expected to be followed by a major advertising blitz. While the service is mainly known as a way to deliver broadcast video to cell phones, its music and radio talk channels could prove equally, if not more, popular with subscribers. "Video is a less-proven category than radio," explains Andrei Jezierski, a founder of technology venture consultancy i2 Partners in New York.
XM's and Sirius's current advantages, meanwhile, could be lessened by conditions imposed by the Justice Dept. or FCC before granting approval. In a year before elections, "nobody wants to be accused of being soft to such a high-profile merger," says Ed Harmon, a partner specializing in mergers and acquisitions and antitrust law at the firm of Thorp, Reed & Armstrong in Pittsburgh. Concessions could include a requirement that the new service provider make some of its unique programming—the reason many people sign up in the first place—available to rival broadcasters. The combined company could also be prevented from signing high-profile, exclusive content deals in the future, S&P's Amobi says.
Another unwelcome possibility: The combined company could also be asked to divest some of the valuable airwaves that many analysts say are likely to be used to provide video services in the future. XM and Sirius could be asked to sell off operations in certain markets, analysts say.
Even if the merger goes through with few concessions, cost synergies might take a while to kick in. In fact, Amobi expects cost savings at the low end of the $3 billion to $7 billion range XM and Sirius mentioned in their Feb. 20 presentation to analysts. One area of cost reduction is content: XM and Sirius can cut out duplicate programming. They also won't be bidding against each other to acquire high-profile talent. Back in 2004, Sirius struck a $500 million, five-year contract with talk show host Howard Stern, who received a $83 million bonus last year.
With the merger, those kinds of multimillion-dollar deals might be a thing of the past. Problem is, much of the companies' current content is tied to multiyear contracts, and it might take several years for the merged company to lower its programming costs, says James Goss, an analyst with Barrington Research. "It's not like you can flip the switch, and it's done," he says.
Benefits from having a common infrastructure may not kick in until as many as 10 years from now, Goss adds. The two companies' satellites function differently, using different orbits. Their terrestrial repeaters, used to carry programming from the satellites to subscribers' cars or portable devices, use different technology, too. The merged company will have to maintain two different sets of equipment for years to avoid alienating current subscribers who use older equipment. While XM and Sirius plan to move to a common technology in the coming years, "savings would be on the horizon, but not immediate," says Goss.
Finally, the two companies will have to grapple with the usual integration hurdles—trying to merge two very different corporate cultures, for example. Sirius has long been seen as the more aggressive and risk-taking of the two.
The bottom line, say some analysts, is that the costs of getting together could prove a big counterweight to the benefits, and that as the enlarged company struggles to unlock the cost savings and reach profitability, rivals will make hay.