Satellite Radio Rebooted

The saga of the proposed merger of XM Satellite Radio and Sirius Satellite Radio entered a new chapter in June when Kevin Martin, chairman of the U.S. Federal Communications Commission (FCC), announced his support for a conditional approval of the deal.
The proposed merger between satellite digital audio radio service (DARS) providers XM and Sirius, announced in February 2007, received unconditional antitrust clearance from the U.S. Department of Justice in March, but the FCC has concurrent jurisdiction with the Justice Department to review the merger. Generally, the FCC does not reject mergers approved by the Department of Justice, as the Commission confines itself instead to the imposition of conditions on approval, such as divestitures and programming requirements.
Among the conditions to which XM and Sirius agreed are dedicating 24 channels to non-commercial and minority programming and a three-year price freeze. Although the full FCC had not voted on the conditional approval as of press time — and one or more commissioners were still expressing reservations — the merger likely finally will have closed some sixteen months after it was unveiled.
The XM-Sirius deal originally was announced as a “merger of equals” and structured with a fixed exchange ratio common for such transactions, with each of one party’s (the true but unacknowledged target, XM) shares converted into a fixed number of the other party’s (the unacknowledged purchaser, Sirius) shares based on a negotiated exchange ratio. In fixed exchange ratio “merger of equals” transactions, both parties equally share the risk of movement in purchaser’s share price; the rationale often is based on perceived sector volatility and purchaser’s resulting position that volatility risk in its stock price should be shared.
In the case of XM-Sirius, the original terms of the transaction provided that XM shareholders would receive 4.6 Sirius shares for every XM share. But the value of both companies’ shares have plummeted more than 40 percent since the deal was announced, and XM has been trading at a discount to what 4.6 times even the most bearish forecasts for Sirius would be, probably reflecting market uncertainty about closing the deal as well as for long-term prospects of the combined company.
What are those prospects? Does the merger really solve the DARS sectors’ ills?
The original business plans of the DARS entrants were based on the availability of the service to long-distance drivers who would be able to listen to the same programming coast-to-coast without losing signal. As Sirius and XM gained subscribers, their business models morphed into one based on higher quality service offerings than offered by free radio, with new receivers designed for home use.
Fundamental to the transition were the companies’ specialized, targeted and diverse content offerings. The availability of baseball and football packages as well as the migration of subscriber magnets like Howard Stern transformed DARS service into a content-driven premium service, with the satellite distribution network less important for uninterrupted listening on the move and more important for leveraging the purchased content, much the way syndication operates for terrestrial radio.
XM and Sirius argued for their merger on the grounds that they competed not only with each other but with a wider market of listening choices, including terrestrial radio, streaming Internet radio and handheld MP3 players. The Department of Justice expressly adopted this theory in proposing the order.
The merged companies are going to have to address this competitive landscape, and key to the challenge is a recognition that consumers, particularly younger listeners, have developed an a la carte level of expectations as a result of MP3 use. These changes in expectations have set a higher bar for the potential profitability of prepackaged content packages, with critical partners like the record companies and the car manufacturer distributors putting constraints on potentially profitable service offerings. Content also remains expensive and limits profitability.
It may be that the solution is a cable-like model in which a merged XM-Sirius would offer one or more basic content packages — with premium content available to subscribers. Whether the market will bear that kind of traffic in the competitive landscape that XM and Sirius urged upon the Justice Department and the FCC is another matter.