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LOS ANGELES, May 30 (Reuters) - Whether the two largest satellite radio companies merge or not, the future of the industry is riding on automotive contracts at a time when competition for in-car entertainment is increasing.
Sirius Satellite Radio Inc.'s (SIRI.O) bid to buy XM Satellite Radio Holdings Inc.XMSR.O for $4 billion would help the two companies cut losses, compete more effectively and turn profits faster, the companies have said. But they have also stipulated they don't need the deal to survive since they already have contracts in place to install millions of radios in new cars in coming years.
To date, neither satellite radio provider has yet made a profit. The companies have borrowed heavily to launch their businesses and establish costly contracts with celebrity personalities such as Oprah Winfrey and Martha Stewart, and sports franchises like Major League Baseball.
On a stand-alone basis, analysts project that Sirius will not post a profit until 2010 and XM not until 2011, according to average forecasts from Reuters Estimates.
Both XM and Sirius expect the lion's share of their business to come from automotive deals as retail continues to soften. By 2012, upward of 75 percent of new passenger vehicles sold in the United States are expected to have satellite radios installed, versus 40 percent now, according to Egil Juliussen, analyst with Minnesota-based Telematics Research Group.
"The in-car experience is the most important market for us and will be for the foreseeable future," said David Frear, chief financial officer of Sirius, which added 2.7 million subscribers in 2006, with 42 percent from automotive channels.
For XM, 2006 was the first year it added more new subscribers through automotive channels than retail.
"We expect the trend to continue, validating our early automotive-centric distribution strategy," a company spokesman said.
While carmakers say they remain squarely behind the satellite radio concept, citing good demand, some investors are concerned about competition from in-car digital music players such as iPods, free high-definition digital radio and other gadgets.
Stifel Nicolaus analyst Kit Spring said he expects satellite radio to attain a level of 75 percent penetration by 2012, but added that investors are growing nervous.
"Investors are seriously doubting those penetration metrics due to fears that car companies may install iPod jacks instead," he said. "People were absolutely sure two years ago satellite radios would be standard and now they're unsure."
Other analysts cite concerns about the rate of conversion, the level at which drivers choose to subscribe to satellite radio service at the end of free promotions for installed radios.
"It's not a slam dunk for satellite radio," said Phil Magney of Telematics Research Group. "It might well be that 75 percent of vehicles are enabled for satellite radio, but the question is whether 75 percent will subscribe."
To be sure, officials from carmakers DaimlerChrysler AG DCXGn.DE and General Motors Corp. (GM.N) say satellite radio is a keeper.
"We would definitely say that consumers have latched onto this and we see this as a technology that's going to be around," said Rick Lee, executive director of satellite radio services for OnStar, a division of GM.
But April Horace of Janco Partners believes the auto companies may take a hard look at their satellite radio commitments halfway through current multi-year deals.
"At this point, the automotive roll-out of satellite radio is pretty locked up for the next few years. But, by about 2010, carmakers will look at the conversion rates and consumer satisfaction to decide whether or not to renew," she said.
Jonathan Jacoby, analyst with BankofAmerica, recently cited concerns about conversion rates for both companies. "Lack of transparency on conversion makes it difficult to model longer-term subscriber numbers," he wrote in a Sirius note.
He also cited the conversion rate as a concern for XM, after falling to 51.5 percent in the first quarter from 52.4 percent in the fourth quarter.
"We recently lowered our long-term OEM conversion rate assumption for XM to 45 percent from 50 percent given our belief that higher radio installation rates could pressure conversion rates lower," he said.
Tim Farrar, an analyst with TMF Associates, said he believes that traditional broadcast radio, combined with iPods and similar devices, will prevent satellite radio from ever serving more than 20 percent of the estimated 250 million U.S. cars on the road.
"It's not impossible for them to survive without merging, but unless penetration goes a lot further than 20 percent, their profitability will be somewhat limited," he said.