The Impact Of The Liberty Media Share Purchase On Sirius XM Convertible Debt

 |  About: Sirius XM Holdings Inc. (SIRI), LMCA
by: Crunching Numbers

Most investors in Sirius XM Radio (NASDAQ:SIRI) now know that Liberty Media (NASDAQ:LMCA) has purchased enough shares in Sirius XM to bring its implied ownership above 50%. We found this out in the SEC Form 3's and Form 4's posted on the web sites of both companies or by reading articles from a variety of sources. Curiously, neither company thought it was newsworthy enough to bother with a press release.

It should also be noted that until Liberty converts more of its preferred shares in Sirius XM, it will not actually own a majority of the outstanding shares of common stock. And, although Liberty's preferred shares can be used to vote on most corporate issues that are put to shareholder votes, those shares can not be used to vote for directors of the company. Investors should also be aware that the FCC recently granted Liberty the right to go to de jure control of Sirius XM, and that the approval by the FCC contained the following language:

Liberty Media stated that within 60 days of Commission consent of transfer of control it will purchase sufficient additional shares of Sirius' common stock and will convert its Preferred Shares so that it will own more than 50% of the outstanding shares of common stock of Sirius. Liberty Media has since converted slightly less than half of its Series B-1 Preferred Shares to common shares and purchased additional common shares of Sirius XM. Liberty indicates that the conversion of its remaining preferred stock, and the exchange of senior subordinated notes for common stock, will result in Liberty Media owning approximately 49.5% of Sirius's outstanding common stock. Liberty states that it will purchase sufficient additional shares in the open market and convert the remaining preferred shares to own 50% of Sirius XM common stock, upon the Commission's consent to its acquisition of control.

That 60 day clock started ticking on January 3rd, and the recent purchase of 50 million shares, along with the conversion of the remaining preferred shares would put Liberty above 50%. It's important to understand that converting the preferred shares to common shares in order to go over 50% has two major ramifications. The first is that Liberty loses what Liberty CEO Greg Maffei referred to as "negative controls." This happens once Liberty has converted more than half its Sirius XM preferred shares. Those negative controls allowed Liberty to act solely in its own best interests. When Liberty loses the negative controls, it will replace those with hard controls. While those hard controls allow Liberty to "dictate" the direction of Sirius XM, the minority shareholders will still retain rights that must be considered.

The 7% Notes

The second ramification has to do with the 7% Exchangeable Senior Subordinated Notes (or Notes) due 2014. There are $550 million of these Notes that are scheduled to mature on December 1, 2014, and each $1,000 Note could be exchanged at any time up until three business days prior to such maturity at an initial exchange rate of 533.3333 shares of Sirius XM (an implied price of $1.875/share). For quite some time there has been speculation about what would happen with a change of control with respect to the Notes. The reason for this has to do with a section of the debt agreement titled "Adjustment to shares delivered upon exchange upon certain fundamental changes". (There is also a section of the terms that permits the holders of the Notes to require Sirius XM to redeem the Notes for cash upon certain "fundamental changes", but because the stock underlying the Notes is currently worth so much more than the face value of the Notes, this option is being ignored.)

The initial exchange rate has already been subjected to an adjustment because of the $0.05 dividend paid by the company. That dividend invoked the following clause of the indenture:

(4) if any cash dividend or distribution is made by Sirius to all or substantially all holders of Sirius common stock, the exchange rate will be adjusted based on the following formula:

ER' = ER0 x SP0 / (SP0 - C)


ER0 = the exchange rate in effect immediately prior to the ex-date for such distribution

ER' = the exchange rate in effect immediately after the ex-date for such distribution

SP0 = the last reported sale price of Sirius common stock on the trading day immediately preceding the exdate for such distribution;

C = the amount in cash per share Sirius distributes to holders of Sirius common stock

This adjustment increased the initial exchange rate from 533.3333 to 543.1732 shares per $1,000 Note.

In addition, the following section allows the holders of the Notes to redeem the Notes for additional bonus shares upon certain "fundamental changes."

If you elect to exchange your Notes in connection with a corporate transaction that constitutes a fundamental change described in clause (1), (2), (3) or (6) of such term the exchange rate will be increased by an additional number of shares of Sirius common stock...

So, what constitutes a fundamental change that triggers the additional share (or bonus) provision?

A "fundamental change" will be deemed to have occurred at the time after the Notes are originally issued that any of the following occurs:

(1) a "person" or "group" (as such terms are used in Section 13(d) of the Exchange Act) other than Sirius, its subsidiaries or its or their employee benefit plans, files a Schedule TO or any schedule, form or report under the Exchange Act disclosing that such person or group has become the direct or indirect "beneficial owner," as defined in Rule 13d-3 under the Exchange Act, of Sirius's common equity representing more than 50% of the voting power of the Sirius common equity;

(2) consummation of any share exchange, consolidation or merger of Sirius (excluding a merger solely for the purpose of changing our jurisdiction of incorporation or any share exchange, consolidation or merger between Sirius and any of its subsidiaries) pursuant to which the Sirius common stock will be converted into cash, securities or other property or any sale, conveyance, transfer, lease or other disposition, in one transaction or a series of transactions of all or substantially all of the consolidated assets of Sirius and its subsidiaries, taken as a whole, to any person other than one of its subsidiaries; provided, however, that a transaction where the holders of more than 50% of all classes of the Sirius common equity immediately prior to such transaction own, directly or indirectly, more than 50% of all classes of common equity of the continuing or surviving corporation or transferee or the parent thereof immediately after such event shall not be a fundamental change;

(3) Sirius's stockholders approve any plan or proposal for the liquidation or dissolution of Sirius;

(6) Sirius common stock (or other common stock or depositary shares into which the Notes are then exchangeable) ceases to be listed on a U.S. national securities exchange.

Clearly, clause (1) would be triggered by the conversion of the remaining preferred shares held by Liberty since Liberty would then own "common equity representing more than 50% of the voting power of the Sirius common equity." What is less clear is ("A") whether the holders of the Notes would be better off immediately redeeming the Notes or holding the Notes until maturity while they collect 7% annual interest and ("B") when the Note holders would be required to make a decision. It should also be pointed out that IF the holders of the Notes choose to exchange the Notes at any time, any accrued and unpaid interest will be forfeited.

The following table is an excerpt from a much larger table in the indenture, and shows the additional shares that are offered if a "fundamental change" takes place. If the average price falls between two figures or the average date falls between two dates in the table, the number of additional shares is determined "by a straight-line interpolation between the number of additional shares set forth for the higher and lower stock price amounts and the two dates..." Also, the dividend adjustment to the initial exchange rate would cause a change to the bonus shares and price points. For purposes of this article, only the adjustments for the italicized figures in the table have been calculated.

Additional Shares Upon Fundamental Change

Effective date $2.00 $2.50 $2.95 $3.44 $4.00
12/1/2012 96.5569 62.0035 44.7819 34.1206 26.8308
12/1/2013 69.5290 37.6934 24.5972 17.9393 13.9619
Click to enlarge

Using the interpolation method described above, a recent price of $3.15, and today's date of January 22nd, if the fundamental change were to have occurred today, the bonus shares would be equal to 37.7366 shares, or an additional 7%. If the share price increases, the additional bonus shares decrease. As time passes, the additional bonus shares decrease. And, the Note holder choosing to take advantage of the bonus share opportunity has a small window to make a decision and needs to consider the loss of the accrued and unpaid interest.

It remains to be seen whether or not the holders of the Notes will redeem the Notes for shares or continue to collect the 7% interest.


Once Liberty converts its remaining preferred shares, and if this "fundamental change" prompts the holders of the 7% Notes to redeem the Notes for shares, the diluted share count would rise to nearly 6.9 billion shares. The positive aspect of this is that Sirius XM could realize $38.5 million in interest expense savings as $550 million of 7% debt is removed.

However, nothing with Sirius XM is quite so simple or straight-forward. There has been speculation that a large portion of the short position in Sirius XM is tied to hedging strategies around these 7% Notes. If that's the case, the conversion could do much to reduce the large number of shares sold short, and eliminate any potential short squeeze.

The company would also have an additional 319 million shares outstanding - shares that would cost more than $1 billion to repurchase at the recent price of $3.15. And, if the company were to borrow at the 5.25% rate it obtained last summer, the interest expense would be $52.5 million per year, an increase of $14 million/per year. And, that's IF the company could borrow a sufficient amount at 5.25% and IF the company could buy those shares back at an average price of "only" $3.15, both of which would seem unlikely to occur.

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. I also have a variety of other covered call positions. 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.