If you want a novel approach to making some coin off satellite radio, go ahead and buy XM Satellite Radio (Nasdaq: XMSR) and short an equal dollar amount of Sirius Satellite Radio (Nasdaq: SIRI).

The first reason should be obvious. Buyout terms haven't changed since they were first announced 13 months ago. XM stockholders will receive 4.6 shares of Sirius for every share they own, if and when the merger is completed. With Sirius trading at $2.73, that implies $12.56 worth of Sirius for every XM share outstanding. XM closed out last week at $11.25, a 10% discount to the deal's value.

It's not a risk-free arbitrage bet. Regulators can nix the deal. The merger has to clear both the FCC and the Department of Justice, and financing will also be a challenge. This isn't like Google's (Nasdaq: GOOG) recent $3.1 billion purchase of DoubleClick, which went through the same day that European regulators okayed the pairing. As a merger of equals, each company is carrying sizable debt that must be consolidated as part of the union.

If one firmly believes the deal will go through, buying XM and shorting Sirius would be an easy way to make up the exchange-ratio discrepancy. Since a resolution is likely just months -- not years -- away -- that return would rival most instruments.

Sticking to the plan in inclement weather
The second reason to buy XM and short Sirius is that XM -- not Sirius -- may have the upper hand if the merger falls apart.

Yes, Sirius is growing faster than XM, but there are a few things to consider:

  • XM closed out 2007 with more than 9 million subscribers. Sirius watches over just 8.3 million subscribers.
  • Sirius may be closing the gap -- now standing where XM was just two quarters ago -- but each company counts its users differently. Sirius counts unsold cars in showrooms as subs, so the actual gap of physical subscribers is wider than Sirius's numbers may suggest.
  • Retail has been rough on both companies, pushing the battle to the carmakers. XM has deals with auto companies representing a greater share of the market than Sirius, especially with Sirius partners like Ford (NYSE: F) and Chrysler in retreat.
  • XM launched earlier than Sirius, a move that should produce a greater pool of used cars with XM satellite radio receivers already installed. That will translate into cheap new customer acquisitions without the hardware investment.

The future may be a challenge for both companies as stand-alone operators, but Sirius is the one with the greater market cap, even though XM's the larger company.

The case against shorting
Naturally, a more risk-tolerant investor may want to buy XM without shorting Sirius -- an understandable move. If the deal is approved, both shares should head at least slightly higher in the near term. XM investors will get both the pop and the 10% deal discount by the time the merger closes.

Consolidation will also breed some hefty synergies. Only longs get that, since a long-short position really only plays the arbitragers' game of milking the buyout discount.

Things get riskier if the deal falls apart, of course. The market's initial reaction would be to slam both companies. Since both XM and Sirius would have to ramp up their marketing budgets to attack each other, their financials could get uglier before they potentially got prettier.

Hold that freefall scenario for a sec, though. XM shares closed at $13.98 the day before last year's merger hopes were announced. The stock popped on the news, but it's since given it all those gains back, and then some. In fact, XM shares have already fallen nearly 20% from the pre-merger price.

If axing the deal would imply that the companies are back where they were on Feb. 16, 2007, then XM -- and Sirius too, by the way -- is already cheaper, despite its significantly expanded subscriber count.

So keep hating on XM, non-believers. Nearly all roads seem to point to better days ahead for the longs.

Tune in to these XM updates:

XM is a former recommendation of the Rule Breakers growth stock subscription service. Catch the bridal bouquet and check it out 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. The Fool has a disclosure policy.