Why Does Goldman Hate XM?

You can't accuse Goldman Sachs analyst Mark Wienkes of riding on coattails. He downgraded shares of XM Satellite Radio (Nasdaq: XMSR  ) from neutral to sell this morning, in pointing out that the shares were well above his $11.50 price target.

Whether you agree or disagree with Wienkes, you've got to admire his spunk. When most analysts are starting to feel favorable now that XM's pending hookup with Sirius Satellite Radio (Nasdaq: SIRI  ) is imminent, Wienkes isn't afraid to go against the herd.

Not that Wienkes is convinced that the deal won't go through. He just thinks the recent euphoric gains have discounted the merger as a foregone conclusion, without taking into account the financial impact of concessions that XM and Sirius may have to make to seal the deal.

Since bottoming out this summer, shares of XM have soared more than 50% higher. Both companies continue to lose money, so the uptick is easy to attribute to the upbeat sentiment surrounding the combination of the two companies.

Till death do you start
A combined XM-Sirius company, which would collectively service 16 million subscribers -- a number that keeps increasing -- would be less of a bleeder than the two standalone entities that watch over half that many accounts. Everything from marketing expenses to research-and-development costs and support redundancies will be trimmed and refocused.

"If you combine the two companies, there are billions of dollars -- billions with a b -- that could be saved," Sirius CEO Mel Karmazin told BusinessWeek three months ago. Citi analyst Eileen Furukawa was more explicit in suggesting $7.2 billion in realized synergies.

That's enough to turn bleeders into leaders, but Wienkes isn't so sure.

We've already seen the companies make voluntary concessions. If the merger is approved, the combined company will offer scaled-down subscription plans for as low as $6.99 -- less than half of either company's current pricing. If the pricing and programming flexibility wins over new listeners, that's great. The consumer is already spoiled with self-served digital music through Apple (Nasdaq: AAPL  ) iTunes, as well as buffet servings through Napster (Nasdaq: NAPS  ) and RealNetworks' (Nasdaq: RNWK  ) Rhapsody.  

However, what if lower prices cause existing subscribers to opt in to the lower-margin plans? Even worse, what if Google (Nasdaq: GOOG  ) emerges victorious in the spectrum auction, canvassing the country with subsidized connectivity to the point at which free Internet radio is as feasible as it is portable?

In the end, what if the same factors that lead the Department of Justice to step aside and let XM and Sirius merge are the same factors that will make the merger less lucrative?

The bright side of life
Pretty scary, right? Now let me tell you why I'm not shaking. XM and Sirius will still have inherent advantages in a more competitive marketplace. First you have the original programming. Who is going to pay Howard Stern or Oprah Winfrey tens of millions a year to pry them away after their contracts with Sirius and XM, respectively, expire?

Then you have the established user base. XM and Sirius didn't just trick 16 million subscribers into signing up for monthly service. Satellite radio is comfort food to those 32 million eardrums. Many of those folks already own iPods, belong to music-subscription services, and/or stream Web-based content. As long as satellite radio offers incremental enjoyment, it will be justified as an incremental expense. Churn rates, meanwhile, are reasonable, and automakers continue to expand their satellite-radio offerings in new cars.

The availability of MP3 downloads that play on any digital device isn't forcing Apple to relinquish market share in portable media players. Netflix (Nasdaq: NFLX  ) has more subscribers today than ever, even though more homes than ever before have access to video on demand through their cable providers or Internet-delivered alternatives.

So let's not write off XM and Sirius, with or without a merger. The future can bring many things, but satellite radio still has momentum on its side.

Does Wienkes have the chutzpah to play party pooper here? You bet. Do I think he's wrong? You bet.

Check out some of the more recent articles on the merger:

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