By Olga Kharif The idea of America's major two satellite-radio providers merging has been tossed around almost from the moment Sirius launched its service against XM back in 2002. XM (XMSR) had a year's head start, but as Sirius' (SIRI) share of the market surged, many analysts predicted a duopoly, with both companies eventually splitting the market in half. After all, Sirius' share has gone from about 11% in 2003 to 26% last year and is expected to approach 33% by the end of this year.
Yet, Sirius' surprising strength suggests it might be time for both companies to consider an alliance again. Continued head-butting could slow down both companies' quests to reach profitability. And they'll need financial stamina in the coming months, as they face a mounting threat from a slew of emerging audio technologies. "Financially, [a merger or an alliance] would make a lot of sense," says Craig Mathias, founder of wireless consultancy Farpoint Group.
Both XM and Sirius deny any talk of a combo. But after a year of hand-to-hand combat over programming and subscribers, the rhetoric between the two players is softening -- and that could indicate they might be amenable to hooking up at some point in the future. "It's more important to differentiate ourselves from the other technologies and services that are out there than for either Sirius or us to differentiate ourselves from one another," XM Chairman Gary Parsons told BusinessWeek Online.
DROP IN THE OCEAN. Indeed, a trickle of alternatives is turning into a flood. Digital radio broadcasts, podcasts (recordings of music or talk than can be downloaded onto PCs or portable MP3 players), and song download services via wireless networks are taking off. Come 2006, wireless-network owner Crown Castle is expected to launch an audio and TV service for cell phones -- a market that XM and Sirius are also interested in developing. Worse yet for the satellite boys, Motorola (MOT) is planning to bring out an ad-free wireless audio service for the car market -- XM's and Sirius' bread and butter.
Just like that, the $310 million satellite-radio business is looking like a pond compared to the wider wireless ocean -- and the pond is getting crowded. Rather than duke it out, XM and Sirius may find it more advantageous to present a joint front to competitors.
XM believes it'll reach free cash flows in 2006, and Sirius insists it will break even in 2007. Yet the continuing rivalry could push their break-even targets off by a year, some analysts now estimate.
SNOWBALLING SUBSIDIES. It's not that they're hurting for cash. Each holds more than $630 million in cash and equivalents, and the satellite-radio subscriber base is exploding. On July 1, XM reported that it added 640,000 subscribers in its second quarter, 100,000 above analyst expectations.
But any delay in reaching profitability could mean XM and Sirius would need to raise additional funds on top of mounting debts -- either by floating stock or by selling a chunk of equity to a telco or a cable company. They'll each also need more capital to continue bidding for content and offering radio-hardware subsidies, designed to encourage auto makers and consumers to choose one service over the other.
These subsidies have been snowballing recently -- and they're costly. Both companies underwrite radio hardware and offer several months of service for free to entice subscribers, which means they lose money on each added subscriber for months. So in a strange twist, the recent growth spurt could lead to higher losses. Already, Sirius has offered investors guidance for more red ink this year than previously expected -- $510 million.
SHOCKS TO THE SYSTEM. Content spending is spiraling upward, too. Sirius has scored two giant deals, signing up domestic diva Martha Stewart in April to run a special channel due to launch in the fall, just months after it signed shock jock Howard Stern, whose program is due to start in January, 2006. In February, 2005, Sirius outbid XM for exclusive rights to NASCAR broadcasts from 2007 to 2011, a deal valued at more than $100 million.
At this rate, Sirius' content spending will reach $130 million -- twice 2004 revenue -- by 2007, according to J.P. Morgan estimates. And XM has been striking deals of its own, such as signing up Opie and Anthony to compete with Stern.
Still, differentiating the companies' offerings is becoming increasingly difficult. Today, "there's no structural reason why one of us wouldn't be able to copy what the other one does," allows Jim Meyer, president of operations and sales at Sirius.
PLENTY OF SAVINGS. Indeed, XM introduced its MyFi wearable device last year. Sirius will unveil its own version, which will allow consumers to listen to its broadcasts live or store them for another time, later this year, says Meyer. Both companies are developing technology to stream video to cars and audio to cell phones. "Sirius has historically been behind XM in hardware development, but they've cut the gap considerably," says David Schrier, an analyst with consultancy ABI Research. They've even recently reached parity on rates -- $12.95 a month for month-to-month subscribers for both XM and Sirius.
If they join forces, their subscriber-acquisition costs, ranging from just over $50 for XM and $190 for Sirius, would fall. They wouldn't need all their costly satellites. And their programming costs would also likely plummet.
Such reductions would allow XM and Sirius to better compete with companies offering alternative digital audio options, such as terrestrial radio, which is free and has been cutting back on commercials to battle the competition in the sky.
THE BIG DIFFERENCE. The two companies would have two options for joining forces. First, they could merge. True, they would face antitrust scrutiny from federal regulators. But chances are, the combo would pass muster.
Here's why: Unlike satellite-video companies EchoStar (DISH) and DirecTV, whose merger proposal was rejected back in 2002 because it would have created a monopoly in rural areas, XM and Sirius aren't profitable. They could argue that competition puts a financial strain on their business. Moreover, they don't control a large chunk of the consumer market anywhere.
What's more, the licenses XM and Sirius received from the Federal Communications Commission back in 1997 don't specifically prohibit a merger, says Harold Furchtgott-Roth, a former FCC commissioner who's now president of economics consultancy Furchtgott-Roth Economic Enterprises.
BRANCHING OUT. A content alliance is the other possibility, since Sirius CEO Mel Karmazin, a key architect in the CBS-Viacom merger, might be determined to keep Sirius growing on his own. In that case, perhaps Sirius and XM might agree to pool their programming resources, says ABI's Schrier.
An alliance like this would allow them to focus on rivals as well as opening up new markets, such as delivering satellite radio to cell phone -- a potentially costly undertaking. On July 13, XM announced that it acquired WCS Wireless, which owns wireless licenses that would enable XM to offer additional data and video services. The all-stock deal is valued at nearly $200 million. Both XM and Sirius may have to make more acquisitions to address competitive threats in the coming months.
"The [satellite-radio] market is barely scratched," says Tuna Amobi, an analyst with Standard & Poor's. And with the market expected to grow tenfold by 2009, XM and Sirius could find they're better suitors than fighters.
Kharif is a reporter for BusinessWeek Online in Portland, Ore.