Pacific Crest Downgrades XM

Chad Bartley of Pacific Crest issued the following note on XM:

Deteriorating Fundamentals and Valuation Prompt Downgrade

- Fundamentals in retail channel continue to weaken. Despite ample inventory levels, enhanced marketing and holiday seasonality, XM's challenges at retail persisted in Q4, and the company continued to lose share to Sirius. Equally alarming, demand for satellite radio in general also weakened significantly.

- Estimates drop, but a downward bias persists. We are lowering our 2007 and longer-term revenue, earnings and subscriber forecasts for XM due to the weak retail demand. However, there is still a downward bias due to the challenges at retail and a potentially slower-than-expected rollout of radios at Toyota.

- Merger is still unlikely; even if approved, combination would be difficult. We still believe neither the DOJ nor the FCC would approve a proposed merger of XM and Sirius. That said, any approval process would be lengthy and could distract management, and potential synergies would likely take years to realize.

- XMSR shares are near full value; downgrading to Sector Perform. Based on our lower estimates, we believe fair value of XMSR shares is $16 to $17. Speculation of a merger with Sirius has driven XM's share price to within roughly 5% of fair value, and we believe that material appreciation from these levels is unlikely.