XM-Sirius Merger a Bust for Shareholders

HOWARD STERN SAID Monday on his radio program that he and Oprah Winfrey will soon make a joint statement. Judging by where on Winfrey's person Stern said the loudspeaker will protrude from, I'm guessing the joint statement is a joke. But the item to be announced is quite real: After 17 months of delay amid heavy spending by land-based radio on lobbyists, the Federal Communications Commission voted Friday to permit Stern employer Sirius Satellite Radio (SIRI) to merge with Winfrey host XM Satellite Radio Holdings (XMSR).

Theoretically, fine things should happen now for shareholders. A combined Sirius/XM ought to be able to reduce its spending on marketing, managers, central offices and more. With double the talent, the new company should hold even more appeal for listeners. Fans of both Stern and Winfrey are perhaps few, but fans of Stern and live sports, which XM dominates, are many. Hence, the new company ought to close all the faster on what so far has proved elusive to both Sirius and XM on their own: a profit.

I can't recommend you spend your money on shares, though. In fact, if you own them, consider selling. I suspect both stocks will head well lower in coming quarters now that the last of the merger news is out. Judging by the selloff in both stocks Monday, I'm not the only one who thinks so.

Of course, I have no stake in the success or failure of either company. My opinion is based solely on financials and stock valuations, as it was in April 2004 when I concluded, in a long, dry look at the numbers, that both stocks were vastly overpriced. Sirius has since lost 40% of its value and XM 67%.

I notice a tendency among stock dabblers (but not experienced investors) to think a stock like Sirius is cheap because a share costs only $2 and change. That's a mistake, of course. The price of a stock is irrelevant unless you consider the number of shares outstanding. In fact, Sirius's stock price values the whole company at $3 billion. XM is valued at $2.7 billion. The combined company, then, is worth $5.7 billion. If you wanted to own it free and clear, you'd have to pay that price and then pay off a considerable amount of debt, while applying any cash on hand to the purchase. All told, you'd pay an "enterprise value" of around $9 billion. You'd have a company that produced $2.2 billion in sales over the past year.

Consider some other companies you can own free and clear for $9 billion. There's Tyson Foods (TSN), a poultry processor with 12 times Sirius/XM's sales. There's Coach (COH), with only a third more sales than Sirius/XM, but whose pricey handbags are good for a generous 37 cents of operating profit for each dollar in sales (vs. no profit seen this year or next for satellite radio). Heck, for the cost of Sirius/XM, you could binge and diet at the same time with a purchase of both Burger King (BKC) and Weight Watchers (WTW).

To make up for such a lofty valuation on an unprofitable company, I'd want for Sirius/XM to produce astounding sales growth — the kind that suggests today's losses are merely clearing a path for the rich profits that are just a couple of years off. The companies are indeed adding subscribers via radios installed in new cars, but the home radio business is, as one analyst puts it, on a respirator. As recently as 2006, for example, XM got 48% of new net subscribers from home radios. Last year it was just 13%.

Satellite radio requires a monthly fee, a special radio and, in some cases, the installation of an outdoor antenna. Also, you don't get local content, like weather and traffic reports. I'm a big Howard Stern fan so I happily pay $13 a month for Sirius service, but I listen online through my computer. (Since I have a Mac and Sirius only makes a Windows player, I use not-quite-official software provided thoughtfully by a hobbyist at SiriusMac.com.) One of the early promises of satellite radio — no commercials — hasn't quite held, although Stern's breaks are far shorter on Sirius and are peppered with show content.

The point here is that, in a slowing economy, listeners who are less rabid than I am in their love for a particular show might balk at satellite's price. Drivers seem more willing to pay up, but as I recently noted, June was the worst month for new car sales since the early 1990s, thanks to costly gasoline. And so a combined Sirius/XM is forecast to grow its sales about 21% this year — a healthy pace, but not the doubling in sales I'd need to see to justify today's stock prices. Worse, Sirius announced Monday it will raise funds through a new stock offering. Its size suggests it might dilute the value of existing shares by more than 10%. With heaps of debt remaining and growth slowing, I wonder which will come first: profits or more share offerings needed to keep the bills paid.