XM, Sirius Still Have Much to Prove

The delayed merger between satellite radio operators Sirius SIRI and XM Satellite Radio XMSR may be the least of their problems, as concerns over subscriber adds, rising churn rates and lower revenue per subscriber are leaving analysts cautious heading into their first-quarter numbers.

Analysts currently expect Washington, D.C.-based XM, which is set to release its results on Thursday, to post a loss of 39 cents a share, according to a Thomson First Call survey. New York-based Sirius should lose 7 cents a share, if Wall Street is correct, when it reports on April 29. Since the last reporting quarter's results in late February, shares of Sirius and XM have fallen more than 15%.

The merger partners have chosen not to provide guidance for 2008 amid uncertainty over a forthcoming ruling from the Federal Communications Commission, making it increasingly difficult for analysts to get a handle on each company's performance.

While many expect the FCC to follow in the Justice Department's footsteps in granting regulatory approval, there are fundamental problems that many analysts cannot look past as the satellite operators focus more on the merger than on their respective business.

"Excluding the merger proposal, we do not believe the fundamentals, subscriber growth curves, or risk-adjusted estimates support a premium or equal valuation for Sirius versus XM," wrote Goldman Sachs analyst Mark Wienkes in a Feb. 26 research note. He added that "trends in subscriber adds, churn, and [average revenue per subscriber] confirm our cautious view on the industry."

For Sirius, increases in the churn rate and subscriber acquisition costs, or SAC, are what especially trouble analysts, especially as economic conditions continue to remain shaky. Monthly churn, which measures the number of subscribers who quit the service, is expected to rise slightly from 2.3% in the fourth quarter. At the same time, SAC will likely rise from $90 to a range of $95 to $100, according to several analysts.

Increasing churn and ballooning SAC also pose a threat to expectations for XM's first-quarter results. Perhaps more troubling is the pronounced decline in auto sales as of late, considering that XM has transformed the company from one that is retail-based to one more focused on original-equipment-manufacturer subscribers. During the previous quarter, XM said retail net subscribers fell 63% from a year ago, while OEM net subscribers surged 110%.

This transition to an OEM-centric model comes as penetration has increased in the automotive sector with the help from partnerships with General Motors GM and Toyota Motors TM. In March, though, GM said light-vehicle sales dropped 13%, while Toyota said it had a monthly decline of 10.3%.

"Recent comments from the automotive industry indicate that many of the issues impacting the subprime [and collateralized debt obligation and loan obligation] market are projected to trickle down and carry negative implications on new car sales, implying around 15 to 16 million units sold in 2008," said Goldman's Wienkes. "As satellite radio operators progress toward an OEM-centric model, watch for primary and derivative effects of a housing and auto slowdown to temper the subscriber ramp."

Analysts also anticipate that the conversion from OEM promotional subscribers, such as those customers who buy a new GM car that comes with years of XM service, will slide over the long term. During the fourth quarter, the conversion rate did rise slightly from 53.9% from 52.4% in the previous year, but the full-year 2007 rate fell to 52.7% from 53.3% in 2006.