Tuesday, January 16, 2007

Wall Street Journal Weighs In On XM-Sirius Merger

Anticompetitive Hurdles Loom Before Any XM, Sirius Merger
By SARAH MCBRIDE and AMY SCHATZ, January 17, 2007, The Wall Street Journal

With speculation on the upswing about a possible merger between satellite-radio rivals Sirius Satellite Radio Inc. and XM Satellite Radio Holdings Inc., the companies face a serious obstacle: Federal Communications Commission regulations that appear to specifically forbid a merger.
Winning approval for any deal, from both the FCC and the Justice Department, may rest in persuading regulators that the two companies face many more competitors than just each other. Competing technologies that have helped damp satellite radio's growth -- like iPods, podcasts and Internet radio -- may give the companies ammunition to persuade regulators that a merger of the only two satellite-radio players isn't a threat to competition.

Merger rumors involving the companies have surfaced periodically over the last year, stoked by Sirius officials like Chief Executive Mel Karmazin, who has said he would be interested in buying XM. Officials at XM typically dismissed the possibility.

But in recent weeks, XM has notably softened its stance. While XM still stops short of saying it is exploring a deal, it no longer rules out the possibility. That has given new life to hopes for a deal. Since the beginning of the year, XM's stock has risen almost 19% and Sirius's 17%.

"I think that absolutely [XM executives] have softened their public posture," says Barton Crockett, an analyst at J.P. Morgan who upgraded both companies to "overweight" positions yesterday. "To my mind, that is a strong indication that they are open to this, at least attempting it."

An XM-Sirius merger is gaining more urgency in the industry as both companies struggle to win consumers. While both firms add new listeners each quarter, neither is reaching the lofty subscriber levels that were expected a few years ago.

The merger talk, to some, seems like a trial balloon intended to gauge the reaction of both investors and regulators. Such advance work may be necessary given that any deal would face significant hurdles.

The companies would need to persuade the Justice Department that a merger wouldn't be anticompetitive, even though it would likely result in higher subscription rates and less consumer choice. The companies, however, say thinking about satellite radio on its own defines the options too narrowly.

"I don't know how you come up with a market definition so that we and they compete only against each other," says David Frear, chief financial officer at Sirius. "We see ourselves competing primarily with terrestrial radio as well as this plethora of new services, including MP3s, Internet radio and cellphones."

Indeed, when satellite radio was first conceived, it was difficult to imagine it would compete with a device like the iPod, which offers the kind of broader listening choice that was the heart of satellite radio's appeal. Much like satellite radio, iPods offer hours of advertisement-free music.
The companies would also need to make a case at the FCC, where there are several regulatory hurdles facing a potential deal. Primary among them is an FCC rule that on the face of it appears to prohibit the two companies from merging. In 1997, when the companies won their licenses, the FCC stipulated that one satellite-radio company wouldn't be permitted to "acquire control" of the other license. The prohibition "will help assure sufficient continuing competition," the regulation states.

Communications lawyers say that the rule could be overturned after a public comment period. Mr. Crockett, the J.P. Morgan analyst, suggested in a report yesterday that the FCC could also permit XM, of Washington, and Sirius, of New York, to hold their licenses in two separate companies while consolidating operating and financial efficiencies.

FCC chairman Kevin Martin hasn't said how he might view a deal, but he could be leaning toward a stricter definition of competition in the satellite-radio arena. When asked about a potential XM-Sirius deal last week at the Consumer Electronics Show in Las Vegas, Mr. Martin pointed to how the agency viewed competition in the satellite-television market during its review of EchoStar Communications Corp. and DirecTV Group Inc.'s failed merger attempt a few years ago. In that case, the FCC took a narrow approach to defining the market for video competition.

Mr. Martin's support for a deal would be critical to its success. The political climate at the Republican-controlled commission has been more strained than usual since Democrats took control of Congress, and it isn't clear that the five-member commission's two Democrats could be persuaded to support a further consolidation of the market, given their staunch opposition to relaxing media-ownership rules.

So far, XM and Sirius don't appear to be lobbying regulators or lawmakers directly to allow a merger. While both companies meet regularly with the FCC to discuss various issues, commission officials say they haven't been meeting with satellite-radio companies or their representatives to discuss a potential merger. Staffers at some key congressional offices -- such as Democrats who oversee commerce and antitrust issues -- also say they haven't taken meetings to discuss a merger.

Some communications lawyers say that if the Justice Department decided not to block a merger, the FCC could likely fall in line, as it has with some recent telecommunications mergers.
Of course, issues between XM and Sirius themselves could be difficult to resolve. Those include how to value each company and which company would end up with more control. Even if they merged, cost savings wouldn't necessarily be as good as investors believe, in large part because each company is locked into long-term contracts with talent such as Sirius's Howard Stern and XM's Oprah Winfrey.

RBC Capital Markets' David Bank says programming costs could fall 50%, but not until 2010; because the companies use different encoding technologies, it would be difficult to merge operating platforms. By 2015, he believes the companies would be saving $360 million annually in costs including advertising and subsidies.

In order to merge, the companies would need to act fast. Lawyers say they would need to get a proposal before the FCC within the next couple of months so the heavy lifting would be finished by the time the 2008 election cycle kicks in. If a Democrat took the presidency, control of the FCC would also switch, making a merger that much harder to pull off...read more: here

Labels: merger, sirius, xm