Goldman analyst Mark Weinkes cut his target on XM Satellite Radio (XMSR) and reiterated his Sell rating, citing a more pessimistic outlook on subscriber growth. Winkes is also sour on XMSR’s high cost distribution and programming model, as well as declining contribution margins. Weinkes:
We are lowering our stand-alone XMSR price target to $5 from $6.50 to reflect our lowered view on the long term subscriber outlook set against what remains a high fixed cost programming and distribution model with declining contribution margins. Specifically, we believe the ultimate universe for satellite radio is increasingly impaired by a both lowered OEM production levels and an array of lower cost/higher value alternatives that may prevent the medium from gaining the critical mass necessary to drive attractive risk adjusted returns to shareholders.
Weinkes goes on to suggest that while both Sirius (SIRI) and XM are capable of soldiering on, there is a fundamental disconnect between the perceived value and fair value of the merger:
While we believe both XM and Sirius could continue to function, merged or unmerged, we continue
to recommend selling shares into merger-related strength given what we perceive as a fundamental disconnect between the ~$9+ billion in industry enterprise value, implying ~$6.5 billion of equity market cap, versus the deteriorating cash flow profile, even giving credit for a merger.
Furthermore, Weinkes points out that the cost of XMSR and SIRI debt is sky-high, and that further capital raises, higher interest expense, and declining ARPUs will dilute earnings and shareholder value:
We think it prudent for equity investors assuming a merger to focus on both the gross and net potential EBITDA synergies as well as the incremental interest expense and potential fines associated with the merger consummation when evaluating the potential return to the equity. We believe equity holders will be worse off, despite the benign quarter, as we believe the current $600mn senior notes offering is likely to price-toyield 15%-16% (pegged to current Sirius debt yields), and a requisite subordinated (we estimate a $750mn-$1bn convertible) offering is still to come. With continued ARPU declines, increasing revenue shares, higher interest expense, and likely dilution upon additional new financing, both elements of FCF/share move in unfavorable directions.
Weinkes reiterates his Sell rating and lowers his price target from $6.50 to $5.00.