Outlook Remains Bright Sirius Merger, Says XM CEO Parsons

XM officials remain optimistic the company’s merger with Sirius will be approved, but they're “prepared to operate… as a stand-alone company” if they're wrong, XM Chmn. Gary Parsons said Thurs. during a call with analysts. But several analysts said in reports this week that the merger seems to be in trouble at DoJ and the FCC.

“Four Congressional hearings on the merger have been completed,” Parsons said: “Numerous newspapers have published editorials… We continue to believe that we will ultimately receive the necessary approvals to proceed with the merger and that it will be a big win for both consumers and shareholders. We also need to emphasize that even without a merger XM is well positioned to be a strong and enduring leader in the audio entertainment category.”

Parsons said review of the merger is proceeding as planned and he expects the FCC to seek comment soon. He said the companies had anticipated getting a 2nd round from DoJ, as they did. Sirius, which is buying XM, has a conference call scheduled May 1. XM reported $8 million in merger related expenses during the quarter.

The outlook is mixed for XM if the merger fails, said Sanford C. Bernstein & Co. in a research note. “Subscriber growth expectations have been ratcheted down repeatedly for XM and for the sector over the past two years, and the ’steady-as-she-goes’ trajectory of growing into a top-heavy fixed cost structure paints an unspectacular picture,” the firm said. “Unless the merger with Sirius is approved -- an outcome that, despite management assurances today, looks at least somewhat unlikely -- a longer term resetting of the fixed cost bar will be necessary. Without it, a ‘limp along’ future may be what’s in store.”

Analyst firm Morgan Joseph said the XM-Sirius merger could be in trouble. “Both companies have faced significant resistance from Congress and industry groups like the NAB which, in our view, has made approval of the merger even more unlikely,” the firm said in a note. “We believe the substantial amount of regulatory hurdles will eventually trip up the deal and that the markets are increasingly pricing such an outcome in the shares of both XM and Sirius.” The firm noted that the focus on the merger comes while “the vital OEM distribution network is expanding rapidly and management’s attention is badly needed.”

The call on first quarter results was otherwise dominated by questions about a slowdown by buyers of cars equipped with XM receivers in taking the service, and about negotiations with car makers. The OEM conversion rate declined to 51.5% from 52.4% in the quarter, a drop noted in many analyst reports on the results. “We are increasingly focused on OEM conversion rates as the OEM channel now accounts for the majority of gross subscriber additions,” Bank of America said in a note. The rate was the subject of the first question from an analyst during the call.

“We think it will stay in the slightly above 50% range,” XM Pres. Nate Davis said. “We're not seeing a dramatic dip. We are not happy with the number going down. We'd rather it go up. But remember, we're not seeing a 10-point drop here. We're seeing a couple of point fluctuation.” Davis said XM has launched several dealer-level incentive programs with GM and Honda that should stabilize conversions.

XM’s relationship with car companies was a main focus of analysts’ questions. Honda and Toyota recently signed 2-year deals to factory-install XM receivers and GM produced its 5 millionth XM-equipped car in Jan. XM officials said Toyota likely will move more slowly than the other 2 automakers, starting with Lexus this year, with all vehicles to be equipped with radios in 2008-2009. “Different companies move at different paces,” Parsons said.

XM said it added 285,000 net subscribers in the quarter, hitting 8 million total. The company said it remains on track to hit the “high teens” in millions of subscribers in 2010. Overall, XM reported a loss of $122.4 million, compared with $151.4 million in the year-earlier quarter. Revenue increased 27% from a year earlier to $264.1 million.

XM officials also confirmed that they are putting less emphasis on development of portable radios, a focus of the company 2005-2006. Davis said new devices will be ready for release midsummer. “The reason you haven’t seen a lot of wearable, portable products is we've been spending time moving through the inventory we've got,” Davis said: “We're not really chasing growth in the retail segment as well, knowing that we had to put more of our dollars -- promotional dollars, market dollars, product development dollars -- into the OEM market.”