Liberty Media (NASDAQ:LMCA) must have found some loose change in the bottom of its deep pockets while waiting to find out the latest on its FCC application for permission to go to de jure control of Sirius XM Radio (NASDAQ:SIRI). It shelled out just over $11 million to purchase another 4,038,700 shares of Sirius XM at an average price of more than $2.73 per share, the highest price it has had to pay thus far. The purchases, which took place on November 9th and 13th, were the first purchases since Liberty closed on its second forward contract for 41,087,753 shares back on October 10th.
As part of its applications:
Liberty Media also has stated that it intends to purchase additional shares of Sirius in the open market. However, consistent with the requirements of Section 310( d) of the communications Act, Liberty Media is seeking Commission consent before converting a sufficient number of Preferred Shares such that Liberty Media will own more than 50 percent of the total outstanding common shares of Sirius.
Liberty has also stated that such ownership change would be made effective within 60 days of consent.
The Cost of Ownership
The latest purchases by Liberty cost nearly 10% more per share than any of its previous purchases. To acquire nearly 615 million shares, Liberty has now spent $1.39 billion plus any fees associated with the two forward contracts. As Sirius XM's executives continue to exercise their stock options, Liberty will need to continue buying millions of additional shares to get to "more than 50%."
Currently Liberty owns 36.65% of the Sirius XM common shares, and once it converts its remaining preferred shares, its ownership increases to 49.15% of the common stock (excluding the shares underlying their 7% Note). To increase its ownership to more than 50%, Liberty needs to acquire more than 55.4 million additional shares. At a price of approximately $2.70 per share (it has been bouncing around a lot while writing this article), that would require spending another $150 million.
Complicating the matter is that once a change of control in the ownership of Sirius XM occurs, a clause in the 7% Exchangeable Notes triggers a bonus provision for the holders of the notes. This would allow the Notes to be redeemed for approximately 10% more shares than the current 533.3333 shares per $1000 Note. Instead of 293.3 million new common shares being issued at expiration of the notes on December 1, 2014, the Notes are more likely to be redeemed as soon as Liberty takes control and there could quickly be another 320 million shares outstanding. If Liberty also needs to buy half of these shares, their cost again increases. At $2.70 per share, 160 million shares would cost another $432 million. (Also, consider what could happen to share prices if Liberty enters the market to purchase more than 200 million shares.)
These two purchases totaling $582 million ($432 and $150 million) means that Liberty may be spending $2 billion or more to meet its commitment to the FCC.
The Sirius XM Share Buyback
It appears that most investors are taking it for granted that Liberty will get approval from the FCC and quickly take control of Sirius XM. It also seems that once Liberty is in control, it will quickly lever up the Sirius XM balance sheet with substantial amounts of new debt so that Sirius XM can begin buying back Sirius XM's common shares. Also, Liberty CEO Greg Maffei has discussed getting the money back on the purchases of common shares needed to take a majority position:
The next 11 points have cost us well over $1 billion something if we got to 51 [percent]. We would probably like to get the bait back on the 11 points.
We've noted that there is flexibility in the capital structure at Sirius, there's plenty of availability for them over the next short-term to lever further and return capital to shareholders including ourselves, and whatever we did, we would be unlikely to want to spin out high basis stock, we'd probably given how much we've already shrunk Liberty Media over the last several years. We'd probably including this Starz transaction, we'd probably be wanting to get that cash back. So, that would be the biggest consideration in our minds, a major one.
So, if Liberty does not want to spin out "high basis stock," it will be requiring Sirius XM to buy back all the shares that Liberty has had to -or will have to - purchase, in addition to an equal number of non-Liberty owned common shares so that Liberty's ownership remains above 50%.
How much will the buyback cost Sirius XM? Obviously it depends on the price per share Sirius XM has to pay, but it will certainly cost a great deal. And, it will probably cost a great deal more than Liberty has had to pay.
Liberty's average price per share so far is just over $2.26/share. If they are required to purchase the additional 55.4 million shares at $2.70 for $150 million to go to majority, their average price paid would be just under $2.30/share. Then there is the issue with the 7% Note.
What happens with the 7% Note? Either Sirius XM buys 320 million shares represented by the Notes or Liberty buys 160 million additional shares, and eventually sells them back to Sirius XM. As noted above, if Liberty is to stay at majority, this would require Sirius XM to but the other 160 million from non-Liberty owners. There is really no change in the number of shares that Sirius XM must eventually buy in order for Liberty to stay at majority, although Liberty has an increased exposure if Liberty has to buy the extra 160 million first before selling them back to Sirius XM.
The Cost To Sirius XM
The way the numbers currently work out, Sirius XM will be required by Liberty to purchase the 615 million shares Liberty already purchased, the additional 55.4 million shares that Liberty still needs to purchase, an equal number of non-Liberty owned Sirius XM shares and the 320 million shares from the 7% Note for a total of 1.66 billion shares. Even if Sirius XM is able to buy back the shares at a low average price of $3/share, it would cost nearly $5 billion. At a price of $2.50 it would cost $4.2 billion and at $3.50 it would be $5.8 billion. If Liberty decides it will conduct a Reverse Morris Trust, Liberty must own more than 50% of the equity of Sirius XM. For this to happen, Sirius XM will need to purchase a sufficient number of extra shares to cover the additional exercise of options (Sirius XM CEO Mel Karmazin still retains options to purchase 30 million shares that will vest on December 31st), and the cost of the buyback increases.
Past statements by Maffei indicated it would take 18-24 months to complete the buyback and get to a point where the Reverse Morris Trust could be implemented. Sirius XM has insufficient cash on hand and future free cash flow to conduct a buyback of this magnitude and will be required to take on a substantial amount of new debt. And, during this time period it can be expected the price of Sirius XM shares will rise, probably driving the cost of the buyback towards - or beyond -the upper end of the range.
Reduction in Outstanding Shares
The reduction in outstanding shares is a bit less clear. Sirius XM has 5,223,596,507 common shares outstanding based on the number reported in the latest 10Q and the options exercised since the October 25th date noted in the 10Q. There are two issues. First, Liberty will eventually be converting the remainder of its preferred shares. Second, the reported diluted share count did not include the shares underlying the 7% note.
So, although the weighted average diluted share count was reported as 6,577,654,000, we know that the effect of options was understated (due to the use of the Treasury Method of Accounting calculation not reflecting what Sirius XM did with the proceeds from the exercise of options) and the 320 million shares (assuming a change of control bonus) underlying the 7% Notes were excluded. This would put the projected diluted count at 6.9-7 billion shares. After the buyback the diluted count would decline to about 5.6 billion shares.
Sirius XM will likely be conducting a very expensive buyback in the not too distant future. It will also be removing a significant number of outstanding common shares as well as a significant number of shares from the diluted share count.
It is difficult to envision a scenario where requisite number of shares can be repurchased in 18-24 months without Sirius XM taking on an excessive amount of new debt. And this should be a concern to all investors in Sirius XM.
Disclosure: I am long SIRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have $3 January 2013 covered calls against most of my SIRI position, as well as some $2 and $2.50 January 2013 and $2.50 December covered calls. I may initiate (or close) a buy stock/sell option position in SIRI, at any time. Also, in addition to long-term holdings, I have recently begun day trading 10,000 share blocks of SIRI and may continue to do so. I have no position in LMCA.