Tuesday, April 17, 2007

A Deeper Look At The CBS Rumor

April 17, 2007

One thing that today illustrated was how fast things can change for Sirius and XM. Clearly there is a lot of money exiting these equities early in the day, but just as clear is that there is a lot of money on the sidelines waiting to hop into Sirius or XM.

The CBS rumor now adds yet another series of thoughts surrounding the proposed Sirius and XM merger.

What if a company such as CBS wanted to get into this business?

Would there be a premium paid?

What becomes of the $175,000,000 break-up fee that is in the terms of the agreement?

Could a buyer swoop in and grab one of these companies while the proposed merger is happening?

Are these companies attractive to outsiders?

Why would a company see Sirius and XM attractive?

Which company is more attractive to an outsider?

Does the thought of a proposed bid by a terrestrial radio firm, or any firm for that matter, give a pause to the thought process of the DOJ? The FCC?

These are all questions that investors in this sector need to ask themselves. None of these questions have an exact answer, so investors typically find themselves trying to guess.

Sometimes taking a step back from the excitement provides enough answers for someone to make a better decision.

First, we should take a look at whether it is possible to even happen. The short answer is that yes, it could happen. There is however a break-up fee of $175,000,000 involved that the acquiring company would likely have to absorb. Does that make an outside deal cost prohibitive? Likely it doesn’t in my opinion. While the sum involved is substantial, the market cap of these companies has gone down by more than that amount since the merger was announced, and it represents about 20% of the proposed subscriber revenue for one of these companies in 2007. More simply stated think of it as the subscriber revenue for 1 quarter. That begins to put the value of the break-up fee into perspective.

If CBS were to express interest in acquiring satellite radio company “A”, they would approach that company’s board to negotiate. The board of Company “A” would then consider the CBS offer in comparison to the benefits of a merged satellite radio company, while also considering the likelihood for merger approval. There are many moving parts, but in the end, if CBS had a strong enough desire, a deal could happen.

Now, we need to consider what about these companies would be attractive to a company such as CBS? There are many things that could be attractive, but the biggest factor is “TOP LINE” growth. Sirius and XM have TOP LINE growth. Typically TOP LINE growth is required to see healthy BOTTOM LINE growth happen. A healthy blend of growth is most desirable.

Both TOP LINE and BOTTOM LINE growth are useful in determining the financial strength of a company, but they demonstrate differing aspects of a company. These types of growth are not interchangeable. BOTTOM LINE is more of a measure of how efficient a company is with its spending and operating costs and how effectively it has been controlling total costs. TOP LINE growth is an indicator of how effective a company is at generating sales and does not take into consideration operating efficiencies which could have a dramatic impact on the bottom line.

Terrestrial radio has started to become more stagnant at the TOP LINE. By contrast, satellite radio is a growing sector with the deals and structure in place to continue to grow on the TOP LINE. Terrestrial radio powerhouses have become very good cost cutters, and are effective at the BOTTOM LINE. This was necessitated by the influx of competition from satellite, internet, cell phones, and MP3 players. The existence of these competitors has made terrestrial radio powerhouses become more efficient.

Thus, in theory, you would be acquiring a medium for TOP LINE GROWTH while being able to maintain your BOTTOM LINE efficiencies. Such a deal could make great economic sense.

Now the tricky part comes into play. Which company is more attractive, or is getting both better? Likely, there would be the same issues that are being bandied about now if a company such as CBS were to try to acquire both. The path of least resistance is likely to go after one. Which is more attractive? Well, XM has a lower market cap, but the enterprise value is what comes into play. According to Yahoo, the EV of Sirius is 5.09 Billion, and XM is 4.79 Billion. Thus, XM is less expensive by $300,000,000. Now you need to consider brand awareness, content contracts, OEM contracts, current market share, future market share, debt load, cash on hand, cash flow, and many other items. In the end, a company such as CBS would have to weigh out all of these items to find the better value, and then tack on $175,000,000 and see if it is still a better value. Arguments of “attractiveness”’ can be made for each company. This piece is not about which is better, merely what the exercise would be to arrive at a potential decision. These are questions that investors who are considering a move in this sector should ask themselves to determine the proper play, or whether or not a play even exists.

One logical question is if you have terrestrial stations, why buy a satellite radio company. The answer is simple yet complex. Think about the ability to deploy sample satellite content on HD radio. Think about the ability to advertise a premium subscription based product on free radio. Think about the ability to broaden the footprint of terrestrial shows via satellite. Think of the ability to advertise on both platforms. Think of the ability to appeal to any consumer, rather than specific niches and price points. There are many reasons a terrestrial radio company would want to get into the satellite business.

Simply stated, an already perplexing situation has had a new element added. That element could come into play at any time, and investors need to be cognoscente of this. The popular belief prior to today was that there would be little action aside from the arbitrage spread with Sirius and XM until the DOJ and FCC are close to a decision (something most people feel is months away). With this new information, investors now have new items to consider.

The point of this piece is not to propagate the rumor of today, but rather to get you the investor to think more deeply into the issues at hand as you consider your investment decisions. Sometimes that requires us to step back and observe an issue from another angle. Looking at the possibilities is free. Not knowing about them can cost you. Stay informed, and think about things like this from all sides.

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4/17/2007 10:58:00 PM

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  • Be leery of any info gleaned from Yahoo. It's using out of date debt and cash balances in its calculations, which makes its futher estimates of EV erroneous.

    Furthermore, with a company like CBS hypothetically looking to buy a satellite radio company, they wouldn't necessarily look at the EV's of the company in the respect that you mention -- as the debt of either company purchased would be assumed by CBS and not paid off. And since the debt loads of these two companies are fairly close, it is of no real consequence. Furthermore, acurrate cash balances would play into this equation heavily, as this cash would become an asset to CBS.

    The most important element in looking at buyout price in this situation is the amount of equity outstanding that would need to be purchased by CBS with cash or CBS shares. In this case, XM's market cap is currently $3.64 billion (pps = $11.90 x 306,082,404 shares reported in the proxy filed yesterday); and Sirius' is $4.42 billion (pps = $3.03 x 1,458,248,306 shares reported in the XM merger agreement dated mid March). This is a difference of $780 million in market caps.

    When factoring in the cash balance aspect mentioned above, since CBS would "pocket" this cash in a buyout... XM's cash balance as of 12/31/06 was $218 million, plus the $288 million netted from the leaseback of XM-4, minus the $44 million paid on the mortgage. This leaves XM with approximately $462 million cash. Sirius' cash/cash equivolent balance as of 12/31/06 was about $408 million.

    Subtracting these cash balances from the equity market caps above, puts XM's NET pricetag at about $3.18 billion and Sirius NET at about $4.01 billion.

    The difference now being about $830 million that CBS (or any potential suitor for that matter) would need to come up with in cash or shares to buyout the equity portion of one of the two satrad companies.

    Clearly, with XM being 21% cheaper than Sirius, it puts them as a takeover frontrunner in this portion of the equation.

    By Anonymous skyfi_2004, at April 18, 2007 12:26 PM  

  • A buyout by CBS for either XM or Sirius, even if a rumor, supports the merger as it demonstrates their is competition and it's not a monopoly. If CBS is considers this and tenders an offer, then this would hopefully either would reject realizing that this would increase the odds of the merger going through.

    By Anonymous Anonymous, at April 18, 2007 12:33 PM  

  • Thank You for the comment. I was trying give an extremely simplified version of what people should look at, and let people arrive at their own conclusions such as you did in your example. I used yahoo because it is easy for people to look up. I agree that they tend to have VERY OUTDATED data in many calculations, but if I used other numbers I would have to edure boatlaods of comments telling me I am using bad numbers. It is kind of a catch 22. For the purposes of the example I spelled out, I saw no harm, as the excercise is theoretical.

    In your example you arrive at a conclusion of XM being 21% cheaper. There are other things to consider as well, such as intangibles that do not show up on the balance sheet, and I am sure you understand that.

    I think you would agree that at this point both companies would be attractive take-over candidates even with a $175,000,000 "bounty" sitting out there, and that if a suitor is serious about their interest in one of these companies, the $175,000,000 is not a substantial hurdle to overcome.

    While EV is not the only metric that a buyer would use, it is a big factor, and most people tend to look at EV as establishing the buyout price of an eqity. You can't simply ignore the debt, just as you can't ignore the cash.

    It could get very interesting....especially if another suitor walks into the picture

    By Blogger SSG, at April 18, 2007 12:57 PM  

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