LCAPA Archive

By Relmor Demitrius -

Sirius XM Radio (NASDAQ:SIRI) was never intended to be two separate companies upon its creation. The inventor, Martin Rothblatt, envisioned only one service that would be capable of financial survival.  Over 15 years later, he was proven correct.  The service was too new and the platforms too similar to differentiate themselves. It is possible the FCC’s design in awarding two separate licenses was to weaken the technology revolution brought forth by satellite radio.  We know that much of what transpired had the constant backing by the NAB lobbyists, and it worked as intended. In February of 2009, with a debt tower looming and a frozen bond market, Sirius XM Radio was forced to sell 40% of the company just to survive.  The company desperately needed the synergies a merger would provide.

The government took over 1 year longer to approve this merger than it did to approve the Exxon-Mobile merger, which allowed a further consolidation of the world’s most crucial commodity.  That simple fact underlines the hypocrisy.  Another fact: both companies were making billions in profits at the time, yet both satellite radio companies were forced to the brink of insolvency, all due to an FCC decision made over a decade prior.  The sheer disbelief that it took that long to reach a decision about two poor discretionary income based services trying to survive is mind boggling.  Mel Karmazin (CEO of Sirius XM) didn’t create these horrific situations the company was thrown into, but he did, as any other business leader would, whatever it took to get them through it.  He was successful.

Today Sirius XM investors are beginning to reap the rewards of patience and belief in a business model they knew would and could be successful.  Surely now its opponents would admit defeat and move on?  With quarter after quarter of rising EBITDA, free cash flow, revenue, and increasing subscriber base, the media, analysts, and the shorts have been wrong about the company since 2009.  The synergies of the model are significant post-merger, with most analysts agreeing that the overall cost savings is actually in the billions.  In just about 10 years time, 6 billion in synergies was estimated possible as analysts pieced together the math.  Just where are we in this timeline of synergies being realized you asked?  Not a bad question, let’s take a look and find out.

First we must understand what the synergies were and how much has been realized up to now.  2009 is easy.  Mel Karmazin in late 2008 told investors exactly what the company was expecting in synergies for 2009. 400 million was the amount given. By the end of December of that year Frear stated it was actually closer to 500 million. So that leaves from 2010 on, still 5.5 billion in conservatively estimated synergies. I actually see this as higher personally, but we will use a low ball figure for purposes of this article.

Most synergies in 2009 came in the form of improved costs on administration line items, such as customer service and other general expenses. They closed the offices of XM Radio, laid off around 2,000 workers, combined call centers, and reduced some channel redundancies now that the companies had combined. This is the majority of that 400 million.

Most synergies according to Greg Maffei (CEO of Liberty Capital (NASDAQ:LCAPA)) and David Frear (CFO of Sirius XM Radio), were from consolidation of spectrum to one signal, renewal of OEM contracts and content contracts, and the synergies of 1 satellite array and 1 service. Almost none of these major synergies has happened to date. GM contract was redone, but other OEM deals are still in play from when XM and Sirius were competing for the same dash boards. Car makers are a valued business partner and Sirius XM generates hundreds of millions of dollars a year for its automakers. Pandora, etc… offer nothing back. Simply a nice little internet addition to appease those who want internet access. Sirius XM still owns the dashboard. Over 60% (could be higher but this is where Sirius XM wants it) have Sirius XM Radio’s installed. 45% of those people will pay for it after it expires. Extremely impressive and a model that is the envy of every company in the world that has something to sell automakers. To get any product in a dash and have it take with a 45% success rate is mind-bogglingly successful for a pay service. I will go on record right now as saying if it were free, it would be 99.99%. If it was $2 bucks it would be probably 90%. The price of the product is where you find the percentage of takers. Same with cable tv when it first started. Only the more wealthy purchased it or those who cared more about good entertainment. Maybe they couldn’t afford it as much as the next guy, but by golly they weren’t going to miss another sports event. Just like Sirius XM customers are beginning to realize. The product is so good, where those who traditionally wouldn’t pay for radio, but in this case, after the trial ended, felt could no longer go back to commercial terrestrial radio.

So let us now analyze the future synergies to come.

1. Content contract renewals. First major synergy was re-signing Howard Stern for reportingly less than his original contract. Since Howard Stern can not leverage XM this time to get more money out of Sirius XM, Sirius XM probably saved money. Opie and Anthony reportedly received either less or the same money as well. With more and more content contracts coming due, more savings are expected.

2. OEM contracts to be redone. Chrysler and Ford contracts are two that should provide similar savings that the GM contract provided. Since the company will not share the details of these contracts, we must use what information we have. Here is from an article I wrote when this deal was announced.

I have listed wording from the filing itself.

“”We entered into an agreement with General Motors to extend the term of XM’s distribution agreement to 2020, to improve the economic terms of the arrangement….” From Q1 2009 10-Q.

We should see some noticeable benefit from this deal by now. If we compare percentage of GM revenue and royalty sharing costs to their overall revenue percentage, we can see if any improvements are being made. Going with percentages removes fluctuations in total revenue, and we will assume steady GM sales throughout. There will be of course some degree of error as GM sales are not static. But compared to overall percentage of cars sold by all brands, the difference should be negligible. In Q1 of 2009 before the GM contract was reworked, 2.9% of total revenue went to pay GM revenue sharing agreements. In Q2 of 2009 it dropped to 2.2% of total revenue. In Q3 of 2009 it was 2.3% of total revenue. In Q4 of 2009 it was 1.8% of total revenue. In Q1 of 2010 it was only 1.3% of total revenue.”

Some may argue that this doesn’t prove anything. I disagree. Q1 2010 to Q1 2009 sub totals were extremely similar and GM market share is usually extremely consistent with other automakers. So in this case, it is useful information. In Sirius XM’s own words they agree this is a synergy realized. Here is a comment from Frear from December 2009.

Frear stated that the new GM contract had “significant savings” over the old contract. The words “significant savings” was a direct quote. So if one OEM contract rework provides “significant savings”, what would all of them provide? Obviously a not realized synergy yet. Here is more of what Frear stated that day in December of 2009. This is from an article I wrote on that UBS conference.

“David Frear mentioned that the huge savings of the merger have not even been realized yet, and still the company has realized over 500 million dollars in synergies from the merger already. The huge savings, as stated by Frear, will come as each and EVERY new contract that comes due, whether it is an OEM deal, talent, or even simple supplier contracts, Sirius XM will gain an advantage over the previous contract.” Gain an advantage over the previous contract. So obviously these synergies are just being realized as well.

3. Combining into one platform and 1 service is “down the road” for the companies as well, as stated by Maffei. This is an ongoing process, with its early stages already being seen. Improved internet service, channel reductions and efficiencies are just one small step to this evolution. Sirius 2.0, which should include interoperable capabilities, is another step in this process. Once this is completed, this would free up bandwidth for other services, a sale, a leasing agreement for data services, or synergies with DISH (NASDAQ:DISH) or DirecTV (NASDAQ:DTV), as both companies have Sirius XM Board exposure now. A coincidence? Hardly. Maffei has stated this is an unrealized synergy that is “down the road”.

4. Combining into one satellite array. Since now Sirius XM will use 3 satellites instead of 6, that will save the company 1 billion dollars approximately alone, starting in 2017. Until then Sirius XM will enjoy no capex costs associated with satellite launches. As I have shown by comments from the company and facts of their filings and stated goals, the synergies of Sirius XM are just now becoming significant and will grow going forward.

Here is a direct quote from Mel Karmazin to leave you with. “We expect to realize $400 million in synergies next year and see this figure growing substantially beyond 2009.”

Growing. Not finished.

Disclosure: Long SIRI

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