Um, millions of customers paying a monthly fee?

Sirius/XM had $2.1B in revenue last year combined, almost entirely subscription revenue.

They didn't give Stern, Stewart or Karmazin $700m in cash, primarily they were given stock options and some of that expense was just the cost of salaries and equipment for the show.

And given the current stock price, Stern's deal is probably worth less than $500M. He got 56M shares in the first two years of the deal, I think he sold much of it, but if he didn't it's worth less than $80M now. Either way, the deal was well worth it to Sirius shareholders. Sirius won the battle because of Stern, XM had a huge lead when Stern signed, around six times more subscribers, and it ultimately ended with a merger where Sirius is the dominant partner. If Stern hadn't been signed by Sirius, they likely would have gone bankrupt.

So to value them now, you have to determine how much money the combined company will make, if any. Combined they burned around $1B in negative cash flow last year. So how will that turn around? The combined company has a bunch of drivers that should improve performance dramatically.

1) They no longer have to pay automakers for exclusivity in competition with each other. In fact automakers may have to pay Sirius XM to add a valued option to their cars. At least costs should decline.

2) There is no more confusion holding up consumer sales about which system to get. Consumers can get XM or Sirius and soon you will have access to the best content from both, whether it is Stern or MLB, etc. Their installed base had still been growing strongly, now growth may accelerate again. Either way revenues should grow substantially over the next few years.

3) Karmazin has announced that it's $5 per month extra to access the other systems content. I.e. if you want Howard Stern on XM, you'll pay $5 per month to get it as part of a best of Sirius package. So revenues should increase.

4) When it comes time to renegotiate content licenses, whether with Stern or sports leagues, Sirius-XM won't be bidding against itself any more. Even if the rights fees don't decline, they'll be able to spread them over many more subscribers. And they don't need to license and program two channels of Hard Rock, Gangsta Rap music Content costs will decline.

5) They can eliminate tons of duplicate expenses in advertising, marketing, support, etc. So operational costs should decline.

I personally have little doubt they will be substantially profitable within a few years, but I haven't done enough research to say whether the current price is attractive or not.

Stern's 56M shares comprise about 1.5% of the company now, assuming he got similar numbers of shares this year and the next two, he'd end up with around 140M or a little less than 5% of the combined company. Plus he likely has an exercise price so he'll end up with less than that.

So I reread the pro-forma 2007 financials in the 8K SIRI just released. Just off the top of my head I made a few assumptions on whàt kind of cuts they could make and what revenue growth to expect and came up with a guess their EBITDA would be $300M-$400M next year. Then I found some recent PR where SIRI reiterated a $300M EBITDA for next year.

So that seems reasonable but it basically just covers paying interest. It also doesn't count depreciation on satellites. But it means they should have an easy route to profitability and they don't have to worry about replacing satellites for around 15 years. And Karmizan is likely sandbagging, I'd bet he beats $300M next year.

So the way I see it is they'll probably add around $500M in revenue per year, about half should make it to the bottom line. If next year they are cash flow break even, every year after that they should add around 8 cents per share in free cash flow. So in 2012 they'll have around 24 cents per share.

So does that make SIRI a buy? Not sure. It all depends on risks because the big free cash flow is so far away. If internet enabled car radios emerge as a serious threat by then, cash flow could be greatly diminished. Due to that risk alone I would not overpay for it. But if it drops below $1 I'd probably consider it strongly.

I took my SWAG thoughts from the previous post and built an excel model which is still very simplistic (no capex calculations, etc) and the more I look at SIRI the less excited I get. The problem is they'll incur significant costs in integration, it will take time to ramp benefits of the merger (new package revenue don't start until October), and they have a large amount of debt to roll over next year. This means if they are making poor progress in 2009 they face dilution from more equity sales, and might even face that if they make good progress.

So it's unclear what the capital structure will look like by the time they start generating positive cash flow (i.e. how many shares and how much debt), and that doesn't look to be before end of 09 at the earliest. After that things should rapidly improve and they'll start churning out free cash flow, but within 4-5 years they'll have to start replacing satellites.

And if the capital markets are tough next year, they might not be able to refinance at good terms or at all (very unlikely, but possible). A smarter guy than me points out that the best route would be a Chapter 11 to jettison excessive programming contracts and debt, they'd emerge a total powerhouse. But that probably nukes all equity.

I love the combination and the business, where else can you get a quasi monopoly with strong growth that's stock is at three year lows? I think in the long run it will be a hugely successful company. But the next two years are so uncertain I'm not buying it now. If it ever drops below $1 I might look at again, but will probably just monitor the cost savings, cash flows, and cash balances to see how it does. This might be the case where buying SIRI for $2 next year is the better risk adjusted investment than buying it at $1.40 today.

I see this as pretty unlikely, especially with talent being paid in stock and with Karmazin picking up a few million dollars worth yesterday, I'm feeling a short term bottom here. I also think that their growth is going to be surprisingly strong post-merger as a lot of people who weren't willing to choose between one or the other satellite companies can now have the best of both worlds. It's anecdotal evidence, but I actually know a handful of people who fall into this category and are looking to get in once they figure out how they can get both baseball+football+hockey+Howard Stern+O&A, or some combination thereof.


All that said, I'm not going to put any money in here right now, as their debt is huge.