Sirius and XM stuck in limbo

NEW YORK (CNNMoney.com) -- It has been nearly five months since Sirius Satellite Radio and XM Satellite Radio announced plans to merge. But the likelihood of the deal passing regulatory muster is still highly uncertain, leaving investors in an uncomfortable state of limbo.

"Whether or not the merger gets approved is the billion dollar question, and at this point in time nobody has a clear answer," said April Horace, an analyst with Janco Partners.

Despite plans to merge, shares of XM and Sirius have tumbled this year as Wall Street is skeptical about chances the deal will be approved by regulators.

Wall Street can't seem to make up its mind regarding the deal's outcome. On the one hand, shares of XM (Charts) and Sirius (Charts) have each plunged more than 20 percent since the companies unveiled plans for their $13 billion merger, which would unite the nation's only two satellite radio services, on President's Day.

The deal that would create a satellite radio giant with more than 14 million subscribers and would bring programming ranging from Sirius's shock jock Howard Stern to XM's controversial Opie and Anthony, as well as broadcasts of all major sporting events and numerous commercial-free music channels under one corporate roof.

Shortly after the merger was announced, many politicians, as well as the National Association of Broadcasters, a powerful trade organization representing the traditional radio industry, voiced their objection to the merger, arguing that a deal would be anti-competitive and hurt consumers.

Sirius and XM, as well as other supporters of the merger, have countered that a deal would actually be good for customers. They've claimed that the market in which satellite radio competes includes free radio as well as portable music devices. In other words, consumers will still have many choices for music and other radio programming.

The two companies have also promised to not raise their subscription rates if the merger is approved. Both charge subscribers a fee of $12.95 a month for their most standard package.

And since the Federal Communications Commission announced on June 8 that it was seeking public comments about the merger, shares of Sirius have surged 12 percent while XM's stock has risen 15 percent.

Investors appear to be betting that the FCC's request for comments is the first step in a process that will ultimately end with the deal getting approved. Current FCC regulations prohibit a merger between the two companies so those rules would need to be relaxed. The Justice Department must also green-light the merger. So what lies ahead for XM and Sirius?

The deadline to submit public comments is July 9. So far, the National Association of Broadcasters, influential research firm the Carmel Group and seventy-three members of Congress have written letters urging the FCC and Justice Department to shoot down the merger. Meanwhile, consumer rights group Americans for Tax Reform, the Hispanic Federation and retailer Circuit City have written letters in support of the deal.

David Bank, an analyst with RBC Capital Market, said Wall Street may have read too much into the FCC's decision to ask for public comments about the deal. He said that's standard procedure and should not be interpreted as a sign that a merger is now more likely to be approved.

That said, Bank does believe that there's a good chance the merger will be given the government's blessing.

"My sense from regulators is that the market will be more broadly defined than simply satellite radio, and for that reason we think there's a better than 50 percent of the chance of the deal going through," Bank said.

To that end, Greg Gorbatenko, an analyst with Jackson Securities, said that the recent launch of Apple's (Charts, Fortune 500) iPhone could also play a role in the government's decision making process, since it is yet one more device that expands the music market.

"The iPhone's been so hot, and that is new since the merger was announced. So that could factor into the equation as more smart phones are available that play music," Gorbatenko said.

Bank added that since Sirius and XM have mentioned that they would be willing to offer some sort of "a la carte" price model to subscribers - i.e. allowing consumers to pay a certain amount only for specific channels they want - this could be enough to say the FCC to approve the deal.

FCC chairman Kevin Martin has been a vocal proponent of a la carte pricing in other forms of media, most notably cable television. Bank believes that if the satellite radio companies agree to a la carte pricing in order to get the deal approved, that could strengthen Martin's hand in forcing cable companies to also offer a la carte monthly plans.

"At the end of the day, Kevin Martin has been fighting hard with the cable industry on a la carte pricing. So if he is able to get those kinds of concessions from satellite radio, then that could be a powerful precedent. I think he would settle for this as opposed to killing the merger outright," Bank said.

With that in mind, Bank said the stocks have room to run. But investors should not expect big gains soon since he does not think there will be much progress on the merger approval front for several months.

"If you are a believer in the merger, there is a substantial amount of upside from the synergies. So if you are playing the takeout, there is compelling upside but visibility is limited," he said.

But Maurice McKenzie, an analyst with Signal Hill Group, isn't as confident about the merger's chances of approval.

"The companies will fight their way through the process but there is a low likelihood that the deal will get approved. I believe the government will view satellite radio as a unique business and that FCC and DOJ will look to maintain a competitive market," he said.

Still, McKenzie thinks both stocks are good bargains. He argues that investors are paying too much attention to the merger saga and not enough to the fact that each company should report positive cash flow within the next year to 24 months. So it might actually be good news if the companies walked away from a deal or had their merger shot down.

"The stocks are significantly undervalued. Attention has been drawn away from the fundamentals, which are improving. In the near-term, there would be a lot of uncertainty and volatility if the merger is not approved. But longer-term, this would force investors to look at the fundamentals," he said.

Janco's Horace agrees that the stocks could do reasonably well if the companies don't merge. She has a standalone target price of around $3.50 on Sirius, which is about 15 percent higher than current levels. And for XM, her target is $15, which is 25 percent above its current price.

Horace added that because of the uncertainty about the deal, there has been some speculation about another suitor coming in to make an offer for XM. She said that some vague rumors started to circulate earlier this month about a potentially higher bid for XM surfacing but so far, there has been nothing to substantiate this chatter.

She said she doubts Sirius and XM plan to walk away from their deal, particularly since there is a $175 million break-up fee that would have to be paid by the abandoning party. But she quickly added that if XM was approached with a higher offer, that could be enough to scuttle the Sirius deal.

"You can never say never," Horace said.

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking relationships with the companies.