So far this month, three Sirius XM (SIRI) insiders - CFO David Frear, its EVP, General Counsel & Secretary Patrick Donnelly, and Director Jack Shaw - exercised options and sold a total of 1,902,133 shares. These latest insider sales bring the total of options exercised and shares sold to more than 30 million since the end of the third quarter. With Liberty Media (LMCA) waiting for FCC approval before taking control of Sirius XM, it is not surprising that many insiders have exercised more than 170 million options and sold shares this year. And if job security with the prospect of new ownership wasn't enough of a concern to these insiders, the prospect of higher taxes on the high income earners next year is an additional incentive to move to cash. On the other hand, the insider with the largest equity position in Sirius XM, Liberty, has bought more than 650 million shares of Sirius XM since the beginning of the year.
Can investors in Sirius XM or Liberty use any of this data as a guide to future price movements? If you follow the advice of Peter Lynch, maybe.
One of the greatest investors of all time, Peter Lynch, was noted as saying that "insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise."
At the time, Lynch noted that an insider might be selling in order to cover a large expense, and his quote still has some value today, but the tax laws have changed with respect to executive compensation. When Congress changed the tax laws to limit corporate deductions for executive salaries and cash bonuses, it opened the door for other forms of compensation, particularly incentive stock options and restricted stock. The only way for the executives to spend what had been their salaries and bonuses is to become insider sellers. So, if insider selling may not be much of an indicator, what about insider buying?
All of the insider sales that took place through the exercise of options was actually a purchase at the option exercise price and a simultaneous sale, but that's certainly not what Lynch had in mind when he was discussing insider buying. What about the Liberty purchases? These are also unusual. Liberty's recent purchases have been made with the intention of increasing its ownership from 40% to a majority position and taking control of Sirius XM.
When Liberty loaned Sirius XM a half billion dollars that allowed the company to stave off bankruptcy nearly four years ago, the transaction was also tied to the purchase of 12.5 million shares of preferred stock. The preferred shares cost Liberty $12,500 and could be converted into common stock representing 40% of Sirius XM. Those shares also came with significantly greater rights (the "Consent Rights" in the Investment Agreement) than the equivalent common shares.
These Consent Rights are broadly defined as:
For so long as an aggregate of at least 6,250,000 shares of B-1 Preferred Stock and B-2 Preferred Stock are issued and outstanding, neither the Issuer [Sirius XM] nor any of its subsidiaries will take any of the following actions without obtaining the prior written consent or affirmative vote of the holders of a majority of the outstanding shares of B-1 Preferred Stock and B-2 Preferred Stock, voting together as a separate class.
Currently, Liberty retains these Consent Rights, which include approval by Liberty before Sirius XM can enter into merger or acquisition agreements, offering new debt greater than $10 million, asset purchase or sales greater than certain limits, and changes to the Sirius XM Certificate of Incorporation. Although Liberty has these negative controls, it can not force Sirius XM to take any particular action. Liberty also has another consideration.
The 40% stake has minimal cost basis. If Liberty wants to distribute this stake to its shareholders, it would incur a substantial tax liability. To avoid this tax liability, Liberty could execute a Reverse Morris Trust, or RMT. It is a motivation that was probably not considered by Lynch when he said insiders buy shares for only one reason, "they think the price will rise." Whether the Sirius XM share prices rise, remain flat or even decline modestly, Liberty's tax savings could exceed any gain or loss realized on the share purchases made this year.
Even more interesting than the accuracy of Lynch's comment is the idea that insider trades are worth following because insiders have more knowledge about the company than any outsider. So how did the insiders fare? The insider sale transactions in the first half of the year were at prices below $2.50 per share, with some as low as $1.83. These insiders would have fared far better had they waited until after the Q3 earnings were released in November before selling their shares.
Liberty, the insider that was buying, did much better, buying 655.8 million shares at an average price of just under $2.29 per share. However, even Liberty was late to the party. Starting their purchases earlier or at a more accelerated pace once they did start buying would have saved the company tens - if not hundreds - of millions of dollars.
Each exercise of options by Sirius XM insiders reduces the Liberty ownership percentage and requires Liberty to purchase more shares if and when the FCC grants Liberty's application to go to de jure control of Sirius XM. The latest insider exercises that took place this month have moved the Liberty ownership percentage down to 49.76% (49.80% if one assumes that Liberty converts its 7% Exchangeable Notes).
Liberty, in its FCC filing, has stated "that it will have purchased sufficient shares of Sirius' common stock and will convert its Preferred Shares such that the transfer of control will be completed within 60 days of Commission consent." Whether Liberty will purchase the additional 15,884,929 common shares (or 12,951,596 shares if they convert the notes) or allow its ownership to rise by ceasing to participate in the recently announced share buyback remains to be seen.
Either way, one of the more significant option insider exercises that will affect Liberty's ownership percentage is likely to come from Sirius XM CEO Mel Karmazin early next year. Karmazin, who has announced he will be leaving the company on February 1st, has 30 million options at an exercise price of $0.43 that will vest on December 31st.
Although insider selling from options exercises is important to the calculation of Liberty's ownership, it should be obvious to Sirius XM investors that insider selling has not been a reliable predictor of share price movements.
Additional disclosure: I have $3 January 2013 covered calls against most of my SIRI position, as I may initiate (or close) a buy stock/sell option position in SIRI discussed in a recent article 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.