The tender offer made by Sirius XM (SIRI), a requirement when there was a change of control at the company, for the 7% convertible notes due 2014 is now complete and very few bond holders took advantage of share premiums being offered.
There are some interesting implications regarding this involving strategy, share count, Liberty Media (LMCA) ownership percentage, the share buyback program, share dilution in the float, a possible second tender offer, and even the debt load of the company. That is not all. The short interest could also be impacted because a typical strategy of convertible debt holders is to short the equity.
The Short Story
Sirius XM has always had what many consider a high short interest. While the number of shares short does seem substantial, the days to cover that short position have usually been below $10 per share.
Why do convertible bond holders short the equity? The answer is actually quite simple. The bond holders are guaranteed interest. The bonds can also be converted into shares at any time in order to lock in a guaranteed payment, mitigate risk to the downside, and get cash to work on additional investments with the bond holder short the number of shares that are guaranteed under the bond. If the company goes to $0, the bond holder has the cash from the short position. If the price of the stock increases, the bond holder makes money on the interest and then uses the shares from a conversion to repay the shares short. Essentially, it is a win/win proposition and the bond holder is whole no matter what happens.
In theory, if the bond holder had accepted the tender offer, they would liquidate their respective short positions and use the shares tendered to close out. This had the potential to lower the short interest substantially, assuming that these bond holders did the usual short strategy. By not accepting the offer, these bond holders can and likely will remain in their short positions until the bond matures.
Liberty Media Stake
There was potential that the 320,000,000 shares associated with the convertible bonds would have been enough to take Liberty Media ownership below the 50% level. This is not a big deal, as it would likely be a temporary occurrence, but it could have triggered either a Liberty Media purchase of additional stock or kick off the Sirius XM share buyback program. The reason Liberty Media would want to stay above 50% relates to a longer-term strategy involving a spin or a Reverse Morris Trust. Because the bond holders did not convert, the issue regarding 50% ownership is now off of the table.
Had the bond holders converted their bonds, there was serious potential that Sirius XM would have initiated its share buyback program to maintain current ownership levels. Liberty Media would likely have not participated in the program on a pro rata basis until such time that the ownership stake of greater than 50% was not an issue. That scenario can still happen, but Liberty now has options. Liberty can participate initially to get cash if it wants and then not participate to maintain 50%. Another option is that Liberty can still not participate until the share ratio is appropriate and then participate.
Liberty Media has a couple of stated goals. One is to extract some $1.7 billion that was invested into Sirius XM, while another is to not spin any high basis shares. High basis shares are the shares Liberty bought on the open market and through forward purchase contract. The commonly accepted methodology for Liberty to extract this cash is through a share buyback program. Thus, Liberty will be a willing participant when the time is right. The Liberty strategy likely will develop over time and depend on factors such as other deals, the price of shares, and the time left on the 7% convertible notes.
A Second Tender Offer
Sirius XM may still step up to the plate with a more generous tender offer on the 7% convertible notes. The reasons that the company would do this is that it can borrow money more cheaply at this point in time. For that reason alone the company may find it prudent to sweeten the offer. Another reason is to rid itself of covenants tied to the notes, and still another is to solve the issue about short interest in the equity.
The first tender offer was not at all widely accepted. If the company wants to remove these bonds from the market and all of the baggage these bonds carry, it may decide to sweeten the offer with either cash or additional shares. The long-term implications of removing these bonds from the market is good, but there could be short-term volatility depending on the timing and scope of such an offer. Investors will want to watch this closely.
Expect the short interest of this company to remain at between 350 million and 410 million shares. The company will now not be in a rush to start share buybacks, which makes the dynamic of price fluctuation an interesting dynamic. Expect the debt load to remain similar. Watch for a possible second tender offer. Stay tuned because Sirius XM is getting interesting.