Friday, December 15, 2006

Lehman Sees BIG Upside to a Sirius and XM Merger

December 15, 2006

It is no secret that a combined Sirius and XM would have a huge financial savings. Today, a Lehman report considers the merger and some implications.

Report Excerpts:

On the regulatory side, we believe market definition would be the key issue in approving orrejecting a merger. We think the prospect of a merger increases if event of a merger, the operational cost savings would likely be substantial(we estimate $1.3BN/year by 2013), while capex savings would likely belimited until current satellite fleets reach end of life late next decade. We estimate total value created through the transaction would beapproximately $9BN, on an NPV basis.

-Key regulatory question in assessing merger is likely to be marketdefinition. If DOJ/FTC views market as "satellite radio services," thenapproval is highly unlikely, but if DOJ/FTC views market as "subscription audio services" or "car audio," then even a combined satellite radio companywould be a relatively small portion of the market. We believe a merger would likely be a net positive for customers (wider array of content, pricinglikely stable), but a negative for content suppliers and OEM partners due toshifted negotiation leverage.

-Technical migration would be challenging, as satellite networks and radios are not interoperable would need to maintain both services for multiple years in order to service installed base of aftermarket and OEM customers. Assuming that SIRI's platform were to be adopted and XM OEM sales ceased at YE 2008, we would still expect more than7MM XM-equipped vehicles on the road by YE 2015E.

-We would not expect material changes in the revenue pictures. Combined revenue of two independent companies. We could see a modest increase in subscribers (such as customers who will sign up for a service with both MLB and NFL, but not just one of the two, for example), although we are not modeling any increase in our pro forma. We would not expect prices to rise more than expected under the stand alone scenario, given negative perception implications and fundamental consumer price elasticity.

-Combining the two companies could generate material operational cost savings, in the range of $1.3BN/year, a potential 23%reduction. Potential savings include lower marketing expense (50% ofsavings, with 2013E industry SAC down to $58 from $77), lower OEM revenue share payments (25% of savings), and lower content (for branded content) and fixed operating costs (25% of savings).

-Potential long-term satellite capex savings material($80MM/year), but limited in near-term, as both current satellite fleets would both need to be maintained in order to support existing customer base. Replacement costs could be saved in next satellite replacement cycle late next decade.

-Estimate transaction would potentially create $9BN insynergy value on an NPV basis. If all the synergies are allocated to XM, then XM would be worth $45/share; if all the synergies were allocated toSIRI, then SIRI would be worth $9.50/share (using current market prices as astandalone baseline). Obviously, the allocation of synergies would need to be fair to both parties for a transaction to receive shareholder support.

The report is very detailed and goes deeper into the issues revolving around a merger. One thing that can not be denied is that there would be substantial savings in merging.

12/15/2006 10:01:00 AM

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