With their 18-month quest for regulatory approval finally behind them, Sirius and XM Radio must now turn their attention to making the sought-after merger work -- a job analysts warn will not be easy.

The two companies completed the merger on July 29, the day after the Federal Communications Commission cleared the $2.8-billion all-stock transaction. The new company will be known as Sirius XM Radio and will be based in New York, where it will continue trading on the Nasdaq exchange under the symbol SIRI. With 18.5 million subscribers, it will be the second largest radio broadcaster in the U.S.

Sirius and XM had initially envisioned closing the deal, proposed in February 2007, by the end of last year (AW&ST Feb. 26, 2007, p. 40). However, strong opposition from traditional radio broadcasters and consumer groups, who argued that the alliance would create a harmful monopoly, slowed the process even after the Justice Dept. OK'd the merger last spring, and eventually forced tough concessions that the two companies will have to meet.

Among the conditions imposed were a 36-month freeze on prices; a requirement that the new company rapidly make new combined programming packages and interoperable receivers available to customers; a vow to turn 8% of capacity over for minority and public-access programming, and an agreement to refrain from keeping other manufacturers or terrestrial operators out of the digital audio radio service (DARS) receiver market. The companies were also forced to pay $19.5 million in fines for violation of FCC rules.

Although Sirius CEO Mel Karmazin, who took over the reins of the new company, said it would post an adjusted operating profit and positive free cash flow (discounting expenditures for new satellites) in the first year after the transaction, the conditions are likely to make this difficult, suggests David Joyce, of Miller Tabak. For instance, interoperable radios will have to be on the retail market within nine months, but no schedule has been given for installing such sets on automobiles, where most radios are sold, analysts note. Sirius XM has also offered few details on the mix of programming it will make available for a la carte, "Best of Both" and tailored programming, which it must begin providing within three months of the deal, or the extent to which such programming can be made available with existing radios.

Moreover, if the FCC is unhappy about the degree to which the conditions are met, it reserves the right to extend the price cap beyond the initial 36-month period. And with two of the five commissioners dissenting, this threat must be considered a real one. The FCC also said it would study a further requirement that might force Sirius XM to redesign receivers to accept hybrid digital technology, which allows users to receive terrestrial wireless programming.

Beyond this, Sirius and XM, which have never turned a profit, face the prospect of a swooning economy, morose auto sales and increasing inroads from terrestrial devices like iPods and iPhones. Analysts note that Sirius added only 280,000 net subscribers in the second quarter, fewer than expected, with a high rate of churn.

"We believe integrating the two companies would be a major challenge [even] in a healthy economy," says David Kesten­baum of Morgan Joseph. Kestenbaum predicts the retail market may never recover from the slump, and that plummeting auto sales, although temporary, will make it difficult for Sirius XM to meet its $300-million 2009 forecast for earnings before interest, taxes, depreciation and amortization (EBIDTA).

Another major issue will be how Sirius XM intends to deal with its aggregate $3.4-billion debt. The company says it will issue 262 million new shares -- 180 million priced at $1.50 and the rest later at to-be-disclosed price levels -- to raise new capital. However, Shilpa Parandekar, of Moody's Investors Service, noted that more than $1 billion of debt must be retired by May 2009.

Also uncertain is the ultimate extent of savings that can be realized by the merger. Karmazin says the company will save $400 million next year alone and post continued high savings levels, as well as increased EBIDTA, in the years beyond. But analysts remark that achieving synergies will not be easy.

One difficulty, they note, relates to fleet configuration. Sirius XM currently has three Sirius spacecraft in highly inclined "Tundra" orbits and three XM satellites in geostationary orbit. Although the company has two new GEO units on order, it has not yet said whether it intends to switch to an all-GEO fleet or keep its current mixed-orbit setup, or in fact whether the two orders will be maintained.

A second uncertainty involves the new company's intentions with respect to WorldSpace, in which XM has a 10% stake. WorldSpace has plans to roll out a DARS service in Europe, starting in Italy, next year but has been hemorrhaging cash to an even greater extent than Sirius and XM.

In a note issued in April, Mark Wienkes of Goldman Sachs estimated potential savings at up to $7 billion, but rated Sirius stock a "sell" nevertheless. David Bank of RBC Capital Markets remarks that "the recognition of synergies is probably already priced into stock." Noting that the stock is "valued on multiples of revenue with no cash flow or profitability, facing losses and not showing top-line growth as rapidly as [it has] historically," Stanford Group's Frederick Moran says valuation should be a cause for concern.

However, not everyone is gloomy about Sirius XM's prospects. Tony Wible of Citigroup gives the company a "buy" rating, noting that "the fundamentals of the business are holding up well despite the weak macroeconomic backdrop," and that management's guidance for savings is "conservative."