The title of this week's big winner is shared between Sirius Satellite Radio Inc. (SIRI) and XM Satellite Radio Holdings Inc. (XMSR). SIRI gained under 5% and XMSR gained roughly 10% this week, following an announcement that the two satellite radio rivals will be attempting to merge. More specifically, in this merger, XM shareholders will receive 4.6 shares of Sirius common stock for each share of XM that was originally owned. As well, XM shareholders would hold an equal amount of shares in the new combined satellite radio company as their Sirius counterparts.
For many analysts, this move was inevitable. Individually, the competition for subscribers caused the two rivals to sign big names like Howard Stern (on Sirius) and Oprah Winfrey (on XM), but it is interesting to note that neither business has yet to reach profitability (consequently, both companies have had seen their share prices drop over 25% in the last year). But perhaps through the power of synergy (and the removal of advertising and other competitive costs), operating satellite radio might prove to be profitable business and a good investment for shareholders after all.
However, the Federal Communication Commission and the Department of Justice might object to this union. Since XM and Sirius are the only two providers of satellite radio, a merger would lead to a monopoly, which is something that the government regulators typically disapprove of.
This is not to say the regulators will definitely reject the merger. Most analysts believe that the merger has a chance of succeeding if XM and Sirius can prove that competition will not be eliminated as they will still be competing with other forms of auditory entertainment (such as conventional radio and MP3s). Whether or not regulators will buy that argument is another story.
NovaStar Financial Incorporated's (NFI) share price is plunged into darkness this week, as it dropped from $17.33 to $8.55 (or a decline of 50.8%). The catalyst for this drop was the release of its fouth quarter earnings for 2006. More specifically, the subprime mortgage company revealed that earnings came out to a $0.39 per share loss, which represents a substantail drop from the $0.84 per share profit it earned during the same period a year ago. The dominant cause of the loss is the prevalence of borrowers defaulting on their mortgages.
Unlike most other mortgage lenders, NovaStar deals significantly with issuing subprime mortgages. These mortgages are different compared to conventional mortgages as they are seen to be more risky in terms of default risk, as subprime borrowers tend to have less than stellar credit ratings. In order to compensate for the riskier nature of their business, NovaStar and other subprime borrowers charge higher interest rates on their loans.
In most years, making subprime loans was fairly profitable (for the last 3 years, NFI earned around $25-$30 million per quarter in profit). Unfortunately, defaults in subprime mortgages from the last two of years have increased beyond what was originally predicted, cutting into NFI's bottom line. In fact the situation is so out of control that management believes that from now till 2011, the amount of taxable income earned will very limited.
Most likely, subprime loans lenders like NovaStar and Accredited Home Lenders Holding Co. (LEND) will set higher lending standards and charge even higher interest rates on subprime borrowers. If this indeed does happen, now it might be even more important than ever for consumers to have a good credit rating before applying for a mortgage, as it might be simplier to deal with a financial institution to get a conventional mortgage instead of going down the subprime route.