Does Sirius Really Need XM?

There's been so much talk about the regulatory hurdles that Sirius (Nasdaq: SIRI  ) and XM (Nasdaq: XMSR  ) face to get their merger approved that we've almost forgotten to wonder whether the deal is in each party's best interest.

More to the point, is Sirius overpaying for XM?

It could be. This morning's quarterly earnings report shows Sirius once again growing substantially quicker than rival XM. It landed 556,490 net new subscribers for the March quarter, nearly twice as many as the 285,000 that XM netted over the same three months. With 6.6 million subscribers, Sirius is sticking to its guidance, which calls for more than 8 million accounts by the end of the year. That's a milestone XM passed in April. In other words, Sirius is now less than nine months away from XM. If growth rates continue, Sirius will lap XM in less than two years.

Some Sirius math
The first-quarter report finds revenue at Sirius soaring 61% to hit $204 million. Net loss narrowed by 68% -- to $0.10 on a per share basis -- but that doesn't account for a huge bottom-line hit that Sirius took last year on stock-based compensation. Back that out, and the net loss narrowed by a still-respectable 31%, rising to a deficit of $0.08 per share from a $0.13-per-share loss a year earlier.

Wall Street is likely to warm up to the lower-than-expected loss, even though analysts were also looking for the top line to grow at a more robust 67% clip during the quarter.

There are some trouble spots, of course. Churn rate is up, and advertising revenue is down. That last point is surprising, because Sirius has been pitching its ad revenue potential. It's unusual to see the overall ad revenue shrink, as the subscriber count rate has grown by 61% over the past year.

Sirius is also looking to add fewer subscribers this year than it did in 2006. It started off that way, with 204,697 fewer net subscribers than the 761,187 it tacked on during the March quarter of 2006. That was expected, too, but the underlying metrics are a bit ominous. A surge in factory-installed automaker deals is masking a steep drop in Sirius's popularity at the retail level.

The retail market has typically been where Sirius shines. XM may have been the top dog in the carmaker market -- moving more than 5 million in-dash receivers through General Motors (NYSE: GM  ) alone -- but Sirius was the people's choice. Most car buyers stick with the dealer satellite radio option, but in the consumer electronics superstore trenches, Sirius has been winning the battle, with Howard Stern, Martha Stewart, NFL, and now NASCAR on its side.  

XM isn't necessarily gaining ground on Sirius in retail, but Sirius is slipping in its own vacuum. Net subscriber additions at the retail level fell by a staggering 64%. Yes, that isn't the gross subscriber number. Sirius is working off a larger base of subscribers, especially those who came on board with one-year subscriptions a year ago when Stern came aboard in mid-January of 2006. It's still not a pretty thing to see.

The future of satellite radio
What's eating satellite radio at the retail level? Apple's (Nasdaq: AAPL  ) moving of 100 million iPods isn't helping, especially now that many new model cars are rolling off the assembly line with radio inputs for portable media devices.

And it won't get any easier. Slacker hits stores next month. It's an economical media player designed by digital music pioneers. With Wi-Fi functionality and an in-car satellite option, a free ad-supported music discovery subscription service could eat into Sirius and XM subscribers who are there for the long haul.

On a limited scale but with bigger names, Yahoo! (Nasdaq: YHOO  ) recently teamed up with SanDisk (Nasdaq: SNDK  ) to introduce a Wi-Fi-based player. There is no satellite beaming option, though those iPod inputs will fill in admirably after the players are pre-loaded through Wi-Fi at home or work.

All of this technological innovation, nibbling away at your commuting entertainment experience, is important. Gary Numan had it wrong. "Here in my car, I feel safest of all," he sang. XM and Sirius felt that way too, but that's changing. Now there's the risk of being exposed as a retail-level laggard if the OEM market sputters.

It's already happening. Last week, XM reported that just 51.5% of car buyers are paying for their XM subscriptions after the free trials run out. That's down from a still-disappointing 54.3% clip a year ago. New competition won't help that value proposition, leaving more rolling cars with inactive satellite receivers to worry about.

That would be the easiest argument for a Sirius-XM merger. They need one another at this point. In fact, rival announcements may be what finally clears the deal through those regulatory hurdles.

It's true, but Sirius is billing this as "a merger of equals" at a time when it is the faster grower. XM hosed down its full-year subscriber targets three times last year. If XM is also being naively optimistic in 2007, it may be just a few quarters before Sirius overtakes XM. A more attractive price -- or, at the very least, a more attractive ratio -- could then be had.

However, Sirius is smitten with the economies of scale. It sees it in its own financials, where programming costs and customer service expenses are growing much slower than its top line. The overhead savings of a combined XM and Sirius (with 14.5 million subscribers) is too rich to ignore. In that sense, overpaying for XM today may make more sense than underpaying in a potentially bleaker future.

Sometimes, it's OK to overpay.

XM is a former recommendation of theRule Breakers growth stock subscription service. The newsletter has a pretty decent singing voice, besting the S&P 500 since its inception. Want to take it to the karaoke bar for a few weeks? Go for it with a free 30-day trial subscription.

Longtime Fool contributor Rick Munarriz is such a big satellite radio fan that he subscribes to both XM and Sirius. He does not own shares in any of the companies in this story. He is also a member of the Rule Breakers analytical team, seeking out the next great growth stock early in its defiance. Yahoo! is a Motley Fool Stock Advisor newsletter selection. The Fool has a disclosure policy.


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