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XM, Sirius Team Up To Lose Money

Posted: Jul 31, 2008 11:30 AM by James Brumley

Tickers in this Article: TM, GM, F, XMSR, SIRI

Would you rather have two small companies losing money, or one big company losing money? If you were an owner of satellite radio companies Sirius (Nasdaq:SIRI) or XM Satellite (Nasdaq:XMSR), that's a question you're asking yourself right about now. The two must have figured it would be easier to lose money by teaming up to do it.

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OK, that wasn't quite their intent. The union of the two satellite radio companies to create Sirius XM Radio Inc. is actually designed to cut costs - a lot of them. The merger is expected to save $400 million between the two businesses in 2009 according to the new Sirius XM.

That's all well and good, except for one problem. Saving $400 million isn't going to matter unless some other things drastically change. Both companies are unprofitable by much more than $400 million. They may be forecasting better results going forward, but they haven't exactly "shown me" better results are on the way. (Read more about net income forecasts in Earnings Forecasts: A Primer.)

The Numbers Don't Add Up
Saving $400 million would be a big deal if the two companies hadn't lost $1.2 billion between them last year. Assuming nothing changes for the better or for the worse this year or next year (just for the sake of argument), the new Sirius XM Radio is likely to still lose $800 million on revenue of $2.0 billion.

In their defense, the top and bottom lines are getting marginally better over time. Sirius reported an operational loss of $24 million in a recent preliminary quarterly report, versus a $79 million operating loss for the same quarter a year earlier. And, the combined companies anticipate a positive cash flow come 2009 - excluding capital expenditure for satellites.

Technically this is progress, but I doubt it's enough. Remember, any advantage gained by uniting will also have to offset either a massive financing debt or dilution. Sirius issued $375 million worth of stock on Monday, July 28, to help with expenses, while XM Satellite is going to issue $550 million worth of notes in the near future.

It's not exactly clear how much of that $400 million savings will be eaten into either by dilution or plain-old debt service, but, it's not going to be chump change. (Companies use M&As and spinoffs to boost profits - learn how you can do the same, check out Cashing In On Corporate Restructuring.)

Better Isn't Good Enough
Let's just assume the new company can indeed shave $400 million off the expense line. They're still in the hole by $800 million. Where's the $800 million going to come from to get the company at least to break-even, and more importantly, when is it going to happen?

To its credit, Sirius plans on increasing revenue by 25% in the yet-to-be-officially-reported quarter. That should be about $283 million in Q2 of 2008, versus $226 million in Q2 of last year. And, that's pretty much been Sirius' growth pace for the last year. XM Satellite has grown revenue and its customer base by 17% over the last twelve months, yet actually added a greater number of subscribers last quarter. The thing is, neither outfit has made tremendous headway with operating expenses or costs of revenue. Both have made a little progress, but it's going to take some serious volume to pull them out of the red. That's where the other challenge comes in.

Kudos to XM and Sirius for better sales recently, but the majority of their subscriber growth stemmed from satellite radio installations in automobiles. The number of Sirius retail subscribers increased by only 7% in the second quarter. The rest of the 25% increase came from original equipment manufacturer (OEM) subscriber sales. These are sales resulting from equipment installed in new cars.

It's a great partnership for Sirius and XM; OEM sales have early been twice as strong as either company originally projected for 2008. Ford (NYSE:F), Toyota (NYSE:TM), and Chevrolet - a General Motors' (NYSE:GM) division - have done a particularly good job of getting satellite radios sold.

The potential problem is clear, however. What if auto sales continue to slow? Toyota Motors lowered its forecast on July 29 and now expects 2008 sales to be 9.5 million units down from 9.85 million. Ford's problems have been well-documented. Satellite radio's main growth engine could be shifting into lower gear.

Bottom Line
None of these problems are insurmountable, but it could still be years until XM, Sirius, or the combination of the two can fiscally justify the July 30 announcement. That's a long wait if you're an investor, and a lot can happen in the meantime.

To learn how to invest in companies before, during and after a union, check out The Merger - What To Do When Companies Converge.

By James Brumley

James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.

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