What I am going to write below is speculation, but it is an important bit of speculation that could carry substantial impacts on how Sirius XM (SIRI) trades over the next month. While I am hesitant to use the saying "Perfect Storm", it is exactly what has the potential to be brewing. Please bear in mind that I am laying out possibilities that we all need to consider. The ingredients of the perfect storm are as follows:
- Q4 earnings report where the street is expecting 2 cents a share, while I expect a 4 cents with relative ease and the possibility of 5 cents. This dynamic is happening because I am seeing about $0.016 to hit the books because of booking of NOL's.
- Sirius XM doing a tender offer for the 7% notes.
- Sirius XM's Buyback.
- Liberty Media (LMCA)
Let's tackle these items one at a time and assess the situation that could lead to stock price appreciation.
Sirius XM has already announced that it has met or exceeded all of 2012 guidance. I do not see any surprises here. I think that the call will focus on the 2013 mission of Sirius XM and the guidance for this year. There are many positives SIRI investors have to look forward to this year.
This conference call is not in and of itself a huge catalyst. It should serve to set a good foundation for the equity moving forward though. By itself there would likely be a small pop followed by the obligatory correction.
This issue has some real potential for a few reasons. The good news is that by doing a tender offer for these notes the company will effectively remove $550 million in what most considered toxic debt. The bad news is that there is potentially 320 million shares of dilution.
Typically holders of bonds that convert to shares short the equity. This happens because the bond holder can lock in the delta of the note and generate a guaranteed return by going short the equity and holding the debt. If a company were to fail the bond holder has protections in place and can make money on the short position. If the company moves along and is healthy, the short position can be covered with the convert shares that are tied to the debt.
In this case, because there was a change in control, bonus shares are due to these holders if they convert. Sirius XM has essentially sweetened the pot by adding some additional shares.
Let's assume that you are a bond holder that has a $1,000 dollar note. That note equated to about 533 shares when it was written. In theory, when you bought the note the smart move was to short 533 shares of Sirius XM stock. At the end of the term you would simply turn over the 533 shares that you receive from Sirius XM. As of today you are going to get 581 shares instead of 481. The reason for this was a change in control provision that brought the converting to 571 shares. Sirius XM is adding another 10 shares as an incentive to accept the tender offer.
Now, if you have the cash, you may want to consider closing your short position earlier than the specified March 1 date of the tender offer. Think about this a moment. If you went short at $1.80 and covered at $3.15, you would need to come up with $1,679 to buy shares and cover the short, but you already have $960 from when you went short. In essence, you need only invest $711 to close out the short position.
Here is where it gets interesting. If many bond holders closed the short position earlier it would create buying pressure on the equity which in theory sends the price per share up. The equity would rise in price, and on March 1st you may get 581 shares worth perhaps $3.30 per share, or $1,917. The bond holders could actually cause the price to appreciate and they get an even more handsome reward for doing so. Thus, for a $711 investment today, the potential return is $1,206 and this is not even considering the fact that these bond holders have been collecting 7% interest all along.
With every positive there is a negative. Bond holders typically invest in bonds because they prefer that investment over being in the equity. If you are a bond holder you may likely dump the shares onto the market come March 1st. There are 320 million shares tied to these bonds. That would cause the opposite effect and serve to shrink the share price. Simply stated, we could see a run followed by a correction. This is where the share buyback plan comes into play Sirius XM has a $2 billion share buyback program in play. The company could actually buy into any weakness presented by the 7% note issue.
The other information to consider here is the additional shares from the change of control and the sweetener being offered by Sirius XM per $1,000 bond value. At current prices that represents between $80 million and $90 million that will hit the books in Q1 of 2013 (assuming all bond holders convert). That cost impact will hit as a one time charge in Q1. The company is saving in interest, but those savings would have played out over 24 months instead of 1 quarter. It is worth doing, but the cost impact needs to be considered by investors.
A key ingredient for this perfect storm is the share buyback. If Sirius XM decides to defend the stock price and start they buyback in tandem with the convert shares hitting the market then the appreciation we see from the bond holders covering short positions will have a greater chance of holding.
The flip side of that coin is Sirius XM letting the impact of the additional 320 million shares absorb into the market and then start the buyback. Under this situation more shares would be taken off of the market because the price would be lower.
The beauty here is that either way the stock price has additional defenses in place that would not otherwise be there. Savvy traders will be watching this issue, and in particular the actions of bond holders carefully. There could be some profitable swings in the making.
Where does Liberty fit into all of this? In the cat-bird seat. Liberty holds some of these 7% notes themselves. In fact, Liberty has $11,000,000 worth that will turn into 6.3 million shares.
Liberty can essentially sit back and watch this all play out, participating as needed in share buybacks in order to maintain an ownership level over 50%.
There is a lot happening and there will be many things for investors to watch for over the next couple of months. There is potential that a form of short squeeze could happen if many bond holders feel the equity will appreciate over the next few weeks. We know the bond holders will make money, and we know that Liberty will be in a great position.
The question is what is the best way to play it. A long term holder may simply sit back and be patient having an understanding of the forces at play. An active trader may be in and out playing on any volatility. Even understanding the negatives such as the one time charges that will impact Q1 is important. Look for the short interest to see a decline as this toxic debt is removed. On a last note, there is a satellite to launch at some point here in 2013. If that were to happen in Q1, it could be the quarter where the company cleans its proverbial house. Stay tuned