Friday, April 27, 2007

UBS UPGRADE - More Detail

April 27, 2007

- Upgrading XMSR on improving fundamental outlook in 2H07 Following 1Q07 results, we believe there is improved visibility for an inflection in subscriber growth during 3Q07. We expect 3Q07 net adds of 319k vs. 3Q06 of 286k. Specifically, we believe churn has begun to
stabilize as evidenced by 1Q07 churn of 2.5%, up modestly from 1Q06 and down from 2.8% in 4Q06. While gross adds were weaker than expected in 1Q07, we believe the increases in OEM commitment expected in 2H07 will have a positive impact on gross adds, coupled with the improving churn would lead to increases in net adds.

- Better operational execution at SIRI supports upgrade Ahead of SIRI's 1Q07 results on May 1, we are upgrading the stock to Buy

- Following XMSR's 1Q07 results, we believe SIRI remains the business with better execution as is evidenced by our 485k net add estimate in 1Q07 vs. XMSR net adds of 285k. We believe SIRI will maintain better market share of growth through 2008. SIRI will also benefit from the
continued push toward factory installs among the OEMs in 2H07.

- Increasing targets for both XMSR and SIRI. We base our price targets on detailed DCF analyses for both companies. Our assumptions include 3% growth in perpetuity and 13% WACC for both XM and SIRI. We are increasing our XMSR target to $15 from $13.50 and our
SIRI target to $3.70 from $3.50.

Subscriber Growth Estimates

Upgrading Satellite Radio Stocks We are upgrading XM and Sirius to Buy 2 from Neutral 2. We have increased our XMSR target to $15 from $13.50 and increased our SIRI target to $3.70 from $3.50. Our revised targets represent 27% potential upside for XMSR and 25% for SIRI.

Why now?

We have been Neutral on both XM and SIRI since July 20, 2006. Our concern has been the overall fundamental malaise that has hit both companies since plug-and-play receivers were being held from shipment due to interference concerns. Our focus has been on a recovery in
subscriber growth, which we believe will be led by OEM penetration and will drive further retail growth. We believe the visibility for OEM growth has sufficiently improved that we will start to see a recovery toward the end of 3Q07 and this could translate to improved subscriber
outlook in 4Q07 and into 2008.

- XMSR may be turning the corner a bit sooner than expected. We believe XMSR 1Q07 results provided insight into the efforts management has been making to turn around the business, which is highlighted by the 1Q07 churn result. We believe a number of read-throughs include: annual growth in 3Q07 net additions, one quarter ahead of expectations; sequential growth in net adds through the rest of 2007; and the beneficial impact of OEM penetration on 2H07 and 1H08 outlook.

- SIRI's execution justifies a positive outlook. Our view on SIRI includes the strong execution at the business, which we believe is demonstrated by continued market share dominance and leverage to greater FCF than XMSR. SIRI reports 1Q07 results on May 1, before the open. Following the XMSR results, we believe SIRI's outlook could provide additional positive data points for both companies.

- First quarter 2007 results support upgrade of XMSR. As we have discussed, we believe XMSR has been moving in the right direction with regard to customer retention at both the retail and OEM level. XM has brought its customer service center onshore to the U.S.,
which should improve the overall customer experience. Additionally, XM has moved forward with its OEM partners to actively contact XMSR promotional subscribers as well as use dealer incentive and email programs to improve conversion rates for OEM promotional and free users.

XM passes 8 million subscribers. XM announced it recently passed 8 million subscribers, which implies through April, XM has added over 85k net additions, with May and June traditionally better growth months than April. We believe the growth through April provides support for
sequential growth in net adds for 2Q07, which we estimate will be 300k. We believe 2H07 will experience further strength with 3Q07 generating 319k net adds or 12% year-over-year growth from 3Q06.

EBITDA guidance excluding legal and merger expenses. XMSR provided guidance for 2007 EBITDA loss of $(170) million to $(180) million excluding merger and legal expenses, which was higher than our previous estimate of $(150) million. We believe the difference comes from higher outlook for acquisition costs (CPGA guidance of $111 to $114 vs. UBSe $108) and higher subscriber outlook. We estimate merger expenses are likely in the $25-$30 million range for 2007, including $8 million spent in 1Q07. Accordingly, our revised EBITDA estimate of $(197) million would imply roughly $(170) million excluding merger expenses. We have increased our subscriber estimate to 9.05M from 8.94M and our CPGA estimate to $112 from $108.

Remain comfortable with liquidity position of XMSR. XM ended 1Q07 with $319 million in cash and full access to its $400 million credit facilities. The cash spent to pay upfront MLB expenses ($60M) and capex for XM-5 ($90M) represents the highest cash outlay for the year. While
we do not expect sustainable FCF for XMSR until 2009, we do not project XMSR tapping the capital markets for the life of our model.

- SIRI upgrade on improving industry outlook and execution. As a read-through from XMSR 1Q07 results, we believe SIRI's results will be viewed positively when it reports on May 1. We expect SIRI to report net adds of 485k. While this growth would represent a 36% decline
year-over-year, for the sixth consecutive quarter SIRI will have greater net addition market share than XM. Based on our estimates, SIRI would have 63% market share in 1Q07. We expect SIRI to continue to lead in subscriber growth through at least 2008.

Leverage in the business model will continue to develop. We expect SAC and CPGA to continue to fall for SIRI. While acquisition costs remain higher for SIRI than XM, SIRI continues to benefit from scale and we expect further declines in acquisition costs throughout 2007. Additionally, we believe SIRI has been able to leverage its faster growth into more sustainable cash flow metrics. Due to the expected launch of SIRI-5 in 2008, we believe sustained FCF will be delayed until 2009, in-line with XMSR, but we do not believe SIRI will face any liquidity crunch in the meantime. We expect SIRI to generate greater cash flow from operations than XMSR in 2008.

Second half 2007 could indicate recovery in retail and growth in OEM. Retail remains a weak driver of growth for both companies. Given SIRI has traditionally had greater dependence on retail the continued year-over-year declines in retail gross additions have impacted SIRI's
growth and expected outlook through 2007. We believe late 3Q07 could represent an opportunity for retail growth to annualize easier comps and begin to show positive growth. Coupled with increases in OEM penetration (Mercedes recently announced plans to reach 80% factory installs), we believe SIRI can start to stabilize its growth. We continue to expect
y-y declines in net adds, but this should start to recoup by 1H08.

4/27/2007 09:56:00 AM

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