On the face of it, with no prior information, we should expect this merger to fail. The  fact is, most mergers do. Statistics show (depending upon which ones you believe) that somewhere between 50-80% of mergers and acquisitions result in failure. However, there are reasons to believe that the Sirius-XM deal may buck that trend, …provided that the FCC, FTC, and DOJ allow it to go through.

Typically, if firms have not overpaid for acquisitions to begin with, integration costs often swamp the potential synergies that exist. But I believe, for many reasons, that this merger may be different.

First, the best way to achieve consistent profitability is through the creation of a monopoly. Monopolies allow firms control over pricing. This would, more or less, be the case with Sirius-XM. With no other competitor in the satellite radio space, the merger gives them considerably more pricing power than they have currently. Not surprisingly, this will also be the toughest hurdle to overcome in convincing the U.S. government to bless the union. Likely, the position taken by Sirius-XM will be that they do face substantial competition, not in the form of competitors in their existing space, but in the form of substitutes. They face threats from HD radio, traditional radio, iPod connectivity, internet streaming, etc. So this, they will argue, will put a ceiling on their pricing power. However, the nice thing (from the Sirius/XM standpoint) is that they already have a significant install base – something like 14 million customers combined – and most auto manufacturers install satellite radio enabled head units standard. To the extent that auto manufacturers continue to install satellite-enabled radios in new cars, that will insure a steady stream of potential customers over which Sirius-XM will have a fair amount of pricing power. The combined entity will therefore enjoy some level of pricing power through at least one distribution channel – the new car market.

Second, there are some real cost saving opportunities to this merger. The synergies are real and tangible. Not only do the firms have the ability to economize on administrative costs (e.g., why do we need two sets of management to run these firms), but there are some obvious synergies in production (e.g., why do we need two sets of alternative rock stations when one will suffice).

Third, this merger adds consumer willingness to pay. That is to say, it adds value for customers. Exclusivity contracts negotiated by these separate firms locked-in consumers. For example, fans of Major League Baseball were forced to choose XM while fans of Howard Stern only had Sirius as an option. Combining the firms allows fans of both to resolve issues of which service to choose. Should the merger go through, consumers who have chosen to wait for the uncertainty to resolve over which service would become the standard because they did not like having to choose between two options that are second-best (e.g., I want both Howard Stern and MLB, but I won’t choose until things get resolved) will no longer have to agonize over the decision of which service to select. With Sirius and XM merged, it becomes a no-brainer. More consumers will likely opt for satellite radio. Moreover, to the extent that individual employees of the firm (e.g., radio show hosts) can be re-deployed on channels with differing formats, the consumer experience should be enhanced. Rather than firing one of the alternative rock radio show hosts, for example, we may increase the number of channel offerings by re-deploying that employee as a host on a channel of a different genre (e.g., the punk and rockabilly station) thereby adding value to consumers by increasing variety.

Fourth, the equity markets approved. On the day of the announcement, XM’s (the target firm) shares soared by nearly 10% while Sirius’ (the acquiring firm) shares increased by greater than 5%. Traditionally, because an acquisition represents a re-distribution of wealth from the acquiring firm’s shareholders to the target firm’s shareholders, the acquiring firm’s shares decline, often proportionately to the amount by which it dilutes the value of the acquiring firm. However, equity markets acknowledged the presence of synergies and sent the shares of both companies higher. Although the fact that the equity markets liked the deal is no guarantee of success, it is an indicator that bodes well for its prospects.

Granted, even should the U.S. government allow the merger, it will not be easy to put the firms together. Certainly, organizational impediments to the integration will arise. The firms must execute a joint plan and integrate effectively in order to achieve the synergies present. Can the organizational cultures come together? Will employees at XM resent that their smaller, lower-status brethren is taking "control", resulting in conflict that jeopardizes the integration? Will the costs of integrating the back-end software and the front-end radio head units be greater than expected? Is Mel Karmazin the right person to run the combined entity?

Many of these issues need to be resolved in order for this merger to succeed; however, compared with most others I see that don’t make sense on first glance, this one has potential. We shall see…

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This entry was posted on Wednesday, March 7th, 2007 at 6:11 pm and is filed under Corporate Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.