Question: TEAMING UP FOR SURVIVAL AT SIRIUS XM

Mergers and acquisitions can be exciting opportunities to expand by adding new product capabilities or greater market coverage. Unfortunately, such was not the case when Sirius CEO Mel Karmazin and his counterpart at XM, Hugh Panero, pondered the diffi culties they were facing in the satellite radio business. Neither company had ever turned a profi t, both were deeply in debt, costs were going nowhere but up, and the U.S. economy was slowing down. Karmazin and Panero needed to join forces just to survive, and in early 2007, the companies announced plans to merge. (Although the deal was announced as a "merger of equals," it certainly looked more like an acquisition of XM by Sirius. Karmazin became the CEO of the combined Sirius XM, XM Satellite Radio became a subsidiary of Sirius XM, and Panero left the company later that year. Acquisitions are often presented to the public as mergers to allow the company being acquired to save a little face.) By combining their competing efforts in both technical development and marketing, Karmazin and Panero expected to save $400 million in the fi rst year. Outside analysts fi gured the two companies could eventually save anywhere from $3 billion to $7 billion overall. From a cost perspective, a merger clearly seemed to make sense. A merger might have been the best choice, but it certainly wasn't an easy one. For starters, when the Federal Communications Commission (FCC) granted Sirius and XM licenses to begin service in 1997, the licenses came with the stipulation that the two fi rms never merge.

In addition, numerous members of Congress, consumer advocates, and other media companies spoke out against the merger on the grounds that allowing the country's only two satellite radio companies to merge would create a monopoly in that market. Karmazin and his colleagues had to convince both the FCC and the antitrust regulators at the Department of Justice (DOJ) that the public now had so many entertainment choices that merging would not hurt consumers or restrain competition. The good news/bad news situation for Sirius and XM was that the competitive landscape was indeed so crowded-with terrestrial radio, inexpensive or free Internet radio, digital music players, and music-enabled smartphones-that the two companies were able to convince government offi cials to approve the deal. The DOJ didn't put any conditions on the approval, but the FCC did. First, the company had to agree not to raise prices for three years, a signifi cant matter, given the ongoing struggle for profi tability. Second, it had to give consumers more fl exibility in tailoring subscriptions with the specifi c channels they want. Third, it had to allow any manufacturer to produce and sell radios capable of receiving Sirius XM signals, a move designed to broaden consumer options and lower equipment prices. Fourth, the company had to increase educational programming and make 24 of its satellite channels available for lease by minority- and women-owned media providers. The newly christened Sirius XM made it over all the regulatory hurdles, but life didn't get any easier. In fact, it got a lot worse almost immediately. The company relied on new car sales for a signifi cant portion of its new subscribers-many new cars come with satellite radios as a standard or optional feature, and buyers often get free satellite service for a few months, after which the company hopes they've enjoyed it enough to become paying subscribers. Unfortunately, when the economy collapsed in late 2008, new car sales collapsed with it, squeezing the major source of new customers. To its great credit, the company did manage to keep adding new subscribers in the tough market, but not nearly enough to become profi table. As if that weren't enough, the collapse of the global credit market in 2008 also threw a serious wrench into the company's fi nancial management model. To fi nance those expensive satellites and on-air personalities, the company had been relying on a rolling series of short-term loans. However, those credit faucets dried up practically overnight. By early 2009 Sirius XM was perilously close to bankruptcy, its stock value had plunged to mere pennies per share, and it was vulnerable to a hostile takeover by Dish Network, one of the two major satellite television services.

With disaster looming, Karmazin found help in the form of a massive infusion of cash from Liberty Media, which-not coincidentally-controls DirecTV, Dish Network's major competitor in satellite television. Liberty's money (partly a loan and partly an investment that gave Liberty a 40 percent share of ownership) gave Sirius XM a second chance, but the company's long-range future looked anything but secure. The loan from Liberty came with an eye-popping 15 percent interest rate, and it was only a short-term solution. To prevent anyone else from gaining control while they worked on implementing the merger and pushing the company toward profi tability, Karmazin and the Sirius XM board adopted a poison pill shortly after the Liberty deal that would be triggered if any uninvited buyer acquired more than 4.9 percent of the outstanding stock. Sirius XM was on life support-but it lived. The potential synergies of the merger began to kick in as Karmazin and Panero had predicted, lowering capital and operating costs as the company could now serve a combined subscriber base through a single satellite network and administrative infrastructure. Satellites need to be replaced on a regular schedule, and Sirius XM completed a satellite replacement cycle at the end of 2011, so it won't need to make this massive capital investment again until 2016 or 2017. Operating and marketing effi ciencies improved, lowering the cost of subscriber acquisition (the average amount of money spent to add a new customer). The company renegotiated its contract with General Motors on more favorable terms, and it was said to be pursuing amendments with the other automakers as well. The fees paid for on-air talent are another area of potentially signifi cant cost savings. Although terms of these contracts usually aren't disclosed, on-air personalities who want to be on satellite can no longer play Sirius and XM against each other for bargaining leverage. The revenue side of the balance sheet began looking up as well. In 2010, the economy began to recover, ever so slightly and perhaps not permanently, and car sales started edging up with it.

More than 60 percent of new U.S. car models now have Sirius XM radios built in, and nearly half of those new owners opt for a paid Sirius XM subscription after their initial free trial period. Plus, the fi rst wave of satellite-equipped cars have now cycled through to the used-car market, creating a whole new population of potential customers. In 2010, Sirius XM passed the 20 million subscriber mark, and its average revenue per subscriber increased as well. In fact, thanks to the combination of cost reductions and revenue growth, Sirius began turning things around even while the recession was in full force. Except for some extraordinary one-time expenses involving debt retirement, the company had put together a string of profi table quarters, and its stock price was rebounding in 2011 as well. Liberty, meanwhile, still has its share of the company, and its $530 million investment was worth in the neighborhood of $5 billion by 2011, giving it a "once-in-a-lifetime home run," in the words of one market observer. Sirius XM continues to expand its product offering and availability, with its music, sports, talk, weather, and traffi c channels now available on more than 800 devices, from indash radios to iPads to smartphones. The company's newest product and technology initiative, which includes such features as the ability to buy songs heard over the satellite radio service and to pause, record, and replay audio (much as TiVo and other DVRs do with television service), is dubbed Sirius 2.0. For a company that was pushed to the edge of collapse but found a way to reinvent itself, the "2.0" label is apt in more ways than one.47

1. Other than for purely financial reasons (interest on the loan and potential gains from its investment), why might Liberty Media have wanted to help Sirius XM?

2. The poison pill defense that Sirius XM put in place after the merger expired in 2011, made it at least theoretically possible for another company to buy enough shares to complete a takeover. With its fi nances on much stronger footing and its stock price rebounding, the company has started to look like an attractive investment. If another party (including Liberty Media) eventually acquires Sirius XM because of its attractive stock price and growth prospects, does that mean the merger of Sirius and XM was a failure? Why or why not?

3. In 2011, Sirius XM's stock was added to the NASDAQ 100 stock market index (NASDAQ's index of its 100 largest nonfi nancial companies). One intriguing outcome is that it forces mutual fund companies that offer index funds (see page 448 ) that mimic this particular market index to buy Sirius XM stock. What effect might this change have on the potential for an outsider-welcome or not-to take control of the company?