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Until Mel Do Us Part

Mel Karmazin has finally sealed the deal. After several months of arguing that satellite radio is ripe for consolidation, the Sirius (Nasdaq: SIRI  ) chief has come to terms for acquiring rival XM (Nasdaq: XMSR  ) .

The "merger of equals" will find XM shareholders receiving 4.6 shares of Sirius for every share of XM they own. If the deal goes through -- and that's a big "if," given a fearful FCC -- XM will be taken out at a 22% premium based on Friday's close. Naturally, that will fluctuate based on how the market values Sirius over the next several months.

This would be a great deal for XM, if it goes through. Sirius would also have plenty to gain, despite the dilution. Still, let's break this deal down into the good, the bad, and the ugly.

The good
Massive red ink has been a hallmark of satellite radio. Sirius has burned through $3.6 billion in accumulated losses, and the accumulated deficit at XM runs at an equally meaty $3.2 billion. Actual profitability is still far away, but each company made strides this past quarter to produce positive cash flow on an operating basis. A deal would help fatten that operating performance by trimming down costs.

Servicing 14 million accounts would be cheaper on a per-subscriber basis after the proposed merger. Eliminating redundancies, economies of scale, and incorporating each company's operating strengths will help bring down corporate overhead.

XM and Sirius would also be free to scale back on costly marketing expenses. National ad campaigns don't come cheap, and each company has been spending a lot of that money in trying to belittle its rival. It will be more productive to position each service differently under a kinder climate.

Then again, XM and Sirius swapping vows at the altar may translate into less differentiation and more user customization. Yesterday's announcement alluded to consumers being able to package their own content, including bridging the gap on exclusive licensing deals. Howard Stern on XM? Major League Baseball on Sirius? Better selection and the lack of a cutthroat competitor will give the new company unusual flexibility in pricing its service. This would be a huge advantage, yet it may also be the biggest stumbling block to get the deal approved. Regulators aren't going to smile too kindly here if they interpret the combination as a duopoly morphing into a monopoly.

There are other advantages to the deal, however. Automakers that were pitching just one service may soon be able to offer both with a new wave of compatible receivers. Technology will be kind here. If a single device can offer XM's NavTraffic updates and Sirius' backseat monitor video, the sky could be the limit for the mother of all satellite radio stocks.

The bad
Acquiring XM at a similar market cap to Sirius may hurt shareowners of Sirius. Yes, XM is larger, but Sirius is growing faster and has signed up more net new subscribers than XM for five consecutive quarters.

Sirius shares have been priced at a premium to XM, given its headier growth rates, but that will be sandbagged by XM. Although Sirius added more net new accounts in 2006 than it did a year earlier, the same can't be said for a combined company. XM and Sirius combined to acquire 4.4 million net new subscribers in 2006 after landing 4.9 million subscribers in 2005.

Will investors be willing to pay a premium for slower growth? With roughly 3 billion shares outstanding and a significantly wider float, the go-go days of Sirius will be tame by comparison. Merger synergies will rightly prop up the theoretical value. Whether new investors see it that way or not will be the ultimate test.

Yes, it will be cheaper for Sirius-XM to do things like service its satellite equipment or install universal signal repeaters, but it's going to take a whole lot to move the needle.

The ugly
Does anyone really believe that this deal will clear regulatory hurdles? Five years ago, the FCC shot down a combination of DirecTV (NYSE: DTV  ) and EchoStar (Nasdaq: DISH  ) . Satellite television seemed to have plenty of competitors in cable providers, yet that merger was still derailed.

It appears to be even less promising fox XM and Sirius. Who will they point to as comparable products? Free terrestrial radio? Apple (Nasdaq: AAPL  ) iPod hacks going into many new car models?

If rejection strikes, what will become of XM and Sirius as standalone entities? Over at XM, the stock would give back Monday's gains, as well as any buyout markup that speculators had priced into the shares since they bottomed out over the summer.

Then there would be a change at the top; it is telling that XM CEO Hugh Panero's involvement in the deal is addressed only until the time the merger is completed. It will be Mel's company at that point, but even if the deal falls through, it's hard to fathom Panero holding on.

Back in December, I argued that Panero would be one of four CEOs to be let go in 2007. I've already nailed two of the four with last month's shakeups at Dell (Nasdaq: DELL  ) and Gap (NYSE: GPS  ) . One way or another, this will probably make it three out of four.

Sirius without XM would be in slightly better shape. For starters, it doesn't have the same kind of litigious issues. And while the balance sheets aren't pretty at either company, Sirius still has the scent of a growth stock, despite its recent weakness at the retail level. It should recover sooner than XM, but an official deal smackdown would squeeze out speculators who bid up the stock in anticipation of Monday's announced combination.

Yes, a merger makes sense. Unfortunately, it makes too much sense. Investors buying in on the premise that a combination would be great -- and it would be, for the most part -- also need to embrace the downside potential if the deal falls through.

Drama. Heartbreak. Jubilation. It makes for great radio. Over the next few months, these emotions may come to define these very exciting times in satellite radio.

XM is a former recommendation in the Rule Breakers newsletter service. Dell and Gap are active picks in the Inside Value and Motley Fool Stock Advisor research offerings.

Longtime Fool contributor Rick Munarriz has been a Sirius satellite subscriber since 2004 and an XM subscriber since 2006. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

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