Deutsche Bank Note - Sirius

James Dix from Deutsche Industry Bulletin Research

- FCC Chairman's comments benign on surface, but hint at real problem At a press conference on Wednesday, in response to a question about the possibility of an XM-Sirius merger, Chairman Martin pointed out that the SDARS license grants prohibit a single entity from owning both the satellite radio licenses.

This would not be an insurmountable hurdle to a deal. The FCC could modify such a prohibition if it thought that a merger were in the public interest. That said, discussions we have had with regulatory experts suggest that the FCC's original commitment to having some competition among the satellite operators may trump arguments (reasonable though they appear to be) that the competitive impact of a merger on the audio market would be not be great, given abundant new media audio options. After all, the FCC previously rejected the DirecTV/Echostar merger despite arguments that satellite TV should not be considered a separate market.

Need for high confidence in approval also weighs against a deal. We estimate that it could take at least 6-9 months for the regulators, chiefly antitrust and the FCC, to pass muster on a proposed transaction. We believe that XM and Sirius would want to be fairly confident of approval before they announced a transaction. Given the prospect of FCC turnover or at least delay if the process extended into 2008, these factors indicate that the satellite radio operators have only a few months to get the necessary comfort on the regulatory front. With opposition likely from the NAB among others, such quick comfort may be hard to come by.

Stocks already near “no-merger” support level, in our view. In line with our note last week (see "Post-CES first takes: is sat rad merger 'musthave' feature?" dated 1/11/07), we hypothesize that, absent a merger, and taking the view that the satellite radio industry's growth might be on a riskier trajectory than believed, we think XM could trade near-term at roughly $15 and SIRI at roughly\n$4. We caution that, post-CES, strong fundamental catalysts may not appear until 2H when the OEM channel starts to accelerate. We note, for example, that the Consumer Electronics Association currently forecasts just 2% retail category growth for satellite radio for 2007. Our 12-month target prices for XMSR and SIRI are $20 and $5.75, respectively. We use a DCF through 2010, WACC of 13%-14%, and TVG of 4% to support our target prices.