There has been a lot of speculation about a Sirius XM (SIRI) share buyback and the use of debt to fund a buyback. The speculation has been fueled by repeated comments by Sirius XM on conference calls and at analyst presentations. During the Q3 conference call the issue was again raised by CEO Mel Karmazin:
We will be very under-leveraged in 2013, that the most likely scenario for us is to return capital to our shareholders. This will be discussed with our Board of Directors at our next meeting.
I am not a big fan of buybacks and have written previously about how most companies repurchase their shares when business is strong, the company has excess cash and the share price is high. Sometimes, however, everything lines up for a company and buybacks should be winners. One such case that might seem to fit this category is the recent announcement by Intel (INTC).
The Intel share price has been hit hard in recent months after the company issued weak forecasts. The shares traded above $25 at the start of September and by Thanksgiving had fallen to $19.23, a decline of more than 23%. The company's website reports:
As of September 29, 2012, $6.3 billion remained available for repurchase under the existing repurchase authorization limit and we have repurchased 4.2 billion shares at a cost of $88 billion since the program began in 1990.
Spending $88 billion for 4.2 billion shares comes to $20.95 per share, an average that is still 5% above the current share price. But here is where it starts to get interesting. Note that Intel stated "$6.3 billion remained available for repurchase." Now consider this headline from Bloomberg that reads: Intel Raises $6 Billion in Bond Sale to Buy Back Stock. Here's where things really get interesting.
The article lists the rates and amounts of the debt as:
3 billion of 1.35 percent, five-year securities to yield 75 basis points more than similar-maturity Treasuries, $1.5 billion of 2.7 percent, 10-year bonds at a relative yield of 115 basis points, and $750 million each of 4 percent, 20-year securities at 130 basis points and 4.25 percent of 30-year debt at 150
Currently Intel pays a $0.90 dividend, and with the stock trading below $20 per share, the yield is over 4.5%. So, Intel is borrowing money at an average rate of less than 2.5% to buy back stock that costs the company 4.5%. In addition, the interest expense is tax deductible to the corporation while the dividend payments are not.
Sirius XM has a situation that is very different. Its shares pay no dividends, and any benefit from the tax deductibility of interest expense on borrowed funds is years away. This is because Sirius XM still has more than $7 billion of Net Operating Losses or NOLs on the books that will shelter earnings from Federal taxes for the next five years.
Regardless of my preference to see a dividend from Sirius XM, it is a near certainty that it will be repurchasing shares rather than paying a special dividend as so many other corporations have recently announced. And, it's not only because Karmazin has stated, "Historically, I've always believed that a share buyback is a more tax efficient way of returning capital to shareholders as compared to a dividend." Liberty Media (LMCA) has also discussed a buyback and its executives will be the ones making the decision.
As a result of lending $530 million to Sirius XM nearly 4 years ago, Liberty was able to buy preferred stock representing 40% of Sirius XM for $12,500. As long as Liberty maintains more than half of those preferred shares, it must approve any significant expenditures by Sirius XM. Liberty has spent $1.5 billion acquiring shares over the past year, and has discussed unwinding its investment in Sirius XM through debt and a share buyback by Sirius XM. Liberty CEO Greg Maffei stated:
...I would note, if we pursued that path, something that would weigh on our mind is, we got the first 40% of the company for free virtually. The next 11 points have cost us well over $1 billion something if we got to 51. 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.
Extraordinarily low interest rates for companies like Intel that have excellent credit ratings make borrowing for share buybacks extremely attractive. And when the shares that Intel would be repurchasing have dividends that are more costly than the interest on the new debt, it becomes even more attractive, especially the way that the US corporate tax rates are structured.
While not nearly as attractive as Intel, very low interest rates, growing free cash flow and an improving credit profile for Sirius XM have also made borrowing funds for a share buyback program very attractive for the company. And, with Liberty motivated to cash out of its recent investment in Sirius XM, investors should expect to see an announcement of new debt and a share buyback program early next year.
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 $25 covered calls against most of my Intel position. I have no position in LMCA.