A Sirius Combination?

Sirius CEO Mel Karmazin got investors abuzz Monday when he mused at the Convergence 2.0 conference that he would like to buy rival XM Satellite Radio Holdings (XMSR). That sent shares of both companies skyward on heavy trading volume Monday. XM's shares tacked on 91 cents, or 6.8%, while Sirius's shares added 23 cents, or 5.2%.

There have been murmurs of a deal between the two satellite radio outfits for years now. Sirius CFO David Frear voiced a similar desire to merge with XM during a Morgan Stanley investor conference in late May. But don't expect it to happen. For one thing, the feds would almost never approve it for antitrust reasons. And, it may not make that much business sense.

Sirius, though, is going to have to start delivering more for investors soon. Since the company went public in 1994, investors have certainly been on a ride with the stock, which peaked at $69 in 2000 only to fall below a dollar in 2003. They now trade at $4.55. Losses have weighed heavily on the shares. During its first quarter, Sirius reported a loss of $458.5 million, compared with a $193.6 million loss the year before.

A large deal might lay the foundation for more stable growth. And there are some intriguing options to consider. Probably the most viable partnership to look out for would be similar to the one proposed by Deutsche Bank analyst James Dix in a research note published on June 8. Dix suggests that the satellite-radio operators could expand their offerings to consumers by partnering with telecom providers and offering music via cellphones. It would help fend off recent entrants in the cellphone streaming market like Motorola's (MOT) yet-to-be-launched iRadio, a subscription-based service that offers commercial-free programming not unlike Sirius's offerings. And the cellphone format works great with the portable nature of satellite radio.

Then, there's television. Teaming with DirecTV Group (DTV) or EchoStar Communications (DISH) is a natural extension of Sirius's technology. Plus, the technologies are complementary. But there are some hurdles. For one thing, Sirius already has a foot in that door: In 2004, Sirius inked a deal with EchoStar to offer 110 of its music channels to EchoStar's subscribers in a move to boost its own subscription base. The following year, XM and DirecTV announced a similar alliance. Both radio companies might like dating TV, rather than formally walking down the aisle.

Finally, there's always terrestrial radio, which every few months emerges in the rumor mill as a likely Sirius suitor. For what it's worth, I don't buy that line of thinking. The growth in AM/FM — even with the launch of HD Radio — just isn't what an up and comer like Sirius wants to get involved with. Karmazin is "in a growth business and terrestrial radio is hanging on," says April Horace, an analyst at Hoefer & Arnett. "Would it be all that accretive as a combined unit? Maybe a little, but it's not a home run." Karmazin in the past has said essentially the same thing.

Some investors still hold out hope that Sirius and XM will tie the knot, creating a behemoth that can take on "traditional" media and can save cash on the cost side. But, besides the antitrust hurdles, there are more practical reasons for wanting to avoid such a pairing.

As Horace points out, there is some debate about the actual cost savings the two companies would realize if they merged since they use different satellite technologies to deliver their services. A combined company would mean that subscribers would have to attain hardware — namely antennae and chip sets — that are compatible with both services.

There's also the fact that both XM and Sirius have spent a ton of cash to secure exclusive content. On XM's roster is Bob Dylan, Major League Baseball and Oprah Winfrey (set to launch in September), while Sirius boasts the National Football League, Playboy, and its most recently announced addition, Barbara Walters. For an exclusive five-year deal with Howard Stern, Sirius is paying $700 million. The obscene spending would be all for naught should XM and Sirius link up.

"Both companies are talking about hitting 20 million subscribers each by 2010," adds Horace. "That says to me that the marketplace is big enough to support both of them." On May 24, Sirius reiterated its guidance that it will hit 6.2 million subscribers by the end of 2006, an 87% increase from 2005. XM had reported that same day that it will log in 8.5 million subscribers by the end of the year, 500,000 shy of what it had originally anticipated.

Of course, there's also a strong possibility that Sirius might not do any deals — at least in the near term. After getting everyone all riled up yesterday on the thought of a Sirius-XM deal, Karmazin went on to say "our business plan doesn't involve doing a deal."

Now Karmazin has been around the block and knows that mentioning buying your only competitor at an industry conference is bound to create buzz. Perhaps Karmazin was testing the reaction of shareholders — or even XM — to the idea of creating a unified satellite radio provider.

Or perhaps he's just distracting us while he tries to figure out which option is best.