XM SATELLITE RADIO HOLDINGS

Sirius Satellite Radio

. That's exactly why investors should start thinking about cashing in their shares.

Yes, this "merger of equals," which values the combined company at $13 billion, including $1.6 billion in debt, is aimed at cutting costs and getting the collective bottom line into the black as soon as possible. That should sound like music to the ears of investors who've put up with years of mounting losses. However, between the two regulatory agencies the Department of Justice and the Federal Communications Commission that have to OK this deal and the technological and financial hurdles the companies will face if the deal does get approved, this pairing may not be the match made in heaven that long-term investors have been hoping for.

Even Wall Street, which has applauded the possibility of an XM-Sirius merger in the past, seems skeptical. According to the terms of the deal, which was announced on Monday, XM shareholders will receive 4.6 shares of Sirius stock for each share they own. Given Friday's closing prices, that would put roughly a 21.7% premium on XM's shares at a price of $17.02 a share. However, the stock has only climbed about 11%, indicating that investors are hesitant to fully price in the deal. Sirius's shares are up close to 7%.

Right now, the regulatory hurdles that XM and Sirius face are investors' primary concern. Federal regulations currently prohibit one company from owning both satellite radio licenses. FCC Chairman Kevin Martin said in a statement Monday that the hurdle for these two companies to gain approval is "high" and that they would have to prove that a pairing would ultimately benefit subscribers both in choice and price.

The National Association of Broadcasters, a trade association that lobbies on behalf of radio and television networks, made it clear that the satellite radio operators were going to face a formidable fight. "In coming weeks, policy makers will have to weigh whether an industry that makes Howard Stern its poster child should be rewarded with a monopoly platform for offensive programming. We're hopeful that this anticonsumer proposal will be rejected," the group said in a statement.

XM and Sirius will argue that regulators should change the rules because the digital music market is now flooded with options for consumers such as high-definition radio, MP3 players and mobile phones that play music like Verizon's V Cast. And, of course, there's always good ol' terrestrial radio. They will also argue that by giving subscribers the choice of hearing both Howard Stern (a Sirius show host) and Opie and Anthony (on XM), they are providing them with a broader listening experience.

April Horace, an analyst at Janco Partners, says the likelihood of the merger gaining approval "seems to be anybody's guess." However, she adds that gaining that approval could come with some costly stipulations such as requiring the satellite radio operators to give up part of their spectrum.

Technologies, Synergies Aren't in Tune

Say XM and Sirius manage to gain the government's blessing. Investors should expect an even longer road ahead when it comes to integration and cost synergies. In its press release announcing the deal, the companies said Wall Street's estimates for cost savings range between $3 billion and $7 billion.

By combining the companies could leverage their massive scale to lower supply and manufacturing costs, consolidate sales and marketing staffs and curtail the pricey competition for talent, among other cost-cutting measures. However, Wall Street may be a little too optimistic about just how far and how fast those measures will start to pay off.

"[E]ven a cursory analysis of the fixed and variable costs that might be impacted by the merger suggests that the near-term benefits are likely much smaller than what the rosier consensus estimates imply," wrote Bernstein Research analyst Craig Moffett in a research report Tuesday.

One such problem is that the companies use different technologies to transmit and receive broadcasts. That means something has to be done to bring everything onto the same platform. Janco's Horace says the company is working on an interoperable chip that would allow subscribers to listen to both platforms, but they haven't said how long it will take to get it to market or what they will do about the roughly 13 million subscribers that exist between them using legacy platforms.

"Anything more than the vaguest assessment of cost synergies is impossible without a technology roadmap for integration something the companies have avoided," says Moffett.

That technology shift could prove time consuming and costly not exactly great news for companies that have long struggled to rein in operating costs and have seen their losses mount over the years. In 2006, notes Horace, they were hurt even further by high gasoline prices and slowing sales of gas-guzzling SUVs, whose drivers have been partial in the past to paying up for satellite radio. XM, which is slated to report its 2006 results on Feb. 26, is expected to record $661 million in losses for the year, according to consensus analyst estimates supplied by Thomson First Call. Analysts expect Sirius, which will report Feb. 27, to book $1.1 billion in losses for 2006. Both companies are expected to record negative cash flows and net debt near $1 billion each.

With those losses, Wall Street has grown used to measuring the success of these satellite radio operators by the number of subscribers XM signs on compared to Sirius, and vice versa. Until the merger is approved (or not) they will need to continue to focus their attentions on gaining market share, which may be difficult in light of the amount of attention that will have to be placed on getting this deal approved.

If these two companies become one, we will have to measure their growth using different metrics. One questions whether taking away that competition would stifle the company's motivation to get as many subscribers to sign on as quickly as possible. Attentions could easily become more focused on improving operations. That's not a bad thing business-wise, but it could come at the expense of the growth that investors have long relied heavily on.

For now, though, investors should trust the skepticism of the market and not bank on the fact that these companies will eventually get the premiums promised by the merger agreement. Once the dust settles and XM and Sirius are no longer the "couple of the moment," there's going to be a long wait for investors to get a final answer. In that time, expect a lot of volatility, but very little upside.