Last Fall Sirius XM (SIRI) announced a $2 billion share buyback program along with a new $1.25 billion credit facility. It was news that was widely anticipated because Liberty Media (LMCA) was getting ready to establish control of the company by going over the 50% threshold and there was going to be a point in time when Liberty would seeks to get back some $1.7 billion that it had invested into buying common shares of Sirius XM on the open market and through forward contracts.
Share buybacks can be a wonderful event for shareholders, but in many ways they are a double edged sword. Because of the Liberty Media dynamic this sword could actually be triple edged. Here Is why.
In theory a company buys back shares to return capital to shareholders. The float drops and with less shares on the market the price of the equity should rise. Counter to that is perhaps the fact that a company wants to erase as many shares as possible. This would translate to the company wanting to buy back shares at a less expensive price point. Throw Liberty Media in the mix now and you can add yet another side to this debate.
Liberty Media has purchased about 706,000,000 shares on the open market. That figure, combined with its preferred shares gives Liberty over 3 billion shares. The focus here though is on the 706,000,000 shares.
Liberty Media has expressed that it wants to extract back the $1.7 billion it invested in these common shares. One mechanism to do this is participating in a share buyback on a pro rata basis with other shareholders. The main reason Liberty would want to do this pro rata is to not go under 50% ownership in the company. In theory Liberty, like other share holders, would want to see the stock price appreciate. This would give Liberty more money for fewer shares.
Now it is time to think deeper and consider the 7% convertible notes as well as any management options and the employee stock option program. These stock options and convertibles are tied to about 350 million shares. If these converts were to happen, and all options used, the Liberty Media ownership stake would drop below 50%.
Thus, in theory, Liberty would not likely participate in the share buybacks initially. The company would want the first 350 million shares to be bought from other investors. This would increase the Liberty ownership percentage enough to provide insulation from the dilutive effects of the convertible bonds and the options. It would make sense that Liberty Media would want to see the first 350 million shares bought as cheaply as possible. This would be contrary to share appreciation. To be clear, this is not saying that Liberty wants the share price to decrease, but functionally it makes sense as to why such an eventuality would have positive desired effects for Liberty Media.
Once Liberty Media is fully insulated from dilution it would, in theory, want the share price to appreciate. This is because Liberty would now be selling its shares on a pro rata basis moving forward. In fact, it is perhaps in Liberty's best interest to see the share price move as high as possible. You see, Liberty has shorter term and longer term goals. Shorter term Liberty's goals would be to:
A) Insulate its percentage ownership stake from dilutive impacts
B) Extract $1,7 billion invested
C) Sell back remaining high basis stock to additional buybacks
D) Conduct a Reverse Morris Trust for a tax friendly way to capitalize 2.587 billion shares that were once preferred shares.
The proverbial brass ring here is the 2.587 billion shares capitalized on a tax friendly basis. That brass ring is likely at least two years away, and could be as many as four years out.
As we already know, Sirius XM is using some borrowed money to finance the buybacks. That was and is the intended purpose of the $1.25 billion credit facility. Likely the company will continue to borrow to finance buybacks further. Essentially investors should expect that the debt to EBITDA ratio be about 4 to 1 and remain there until this process is complete. The company is anticipating $1.1 billion in EBITDA growth in 2013, so the theoretical debt limit would be $4.4 billion. If 2014 EBITA goes to $1.4 billion, we could expect the debt load to be in the neighborhood of $5.6 billion and so on for each year. Bear in mind these are not exact numbers. The important thing for investors to understand is that the debt ratio will likely remain pretty constant throughout the time Liberty remains in control.
Because Sirius XM will be using borrowed money to finance portions of the buybacks, it would seem especially true that the company would want to get the maximum number of shares off of the market for the least amount of cash. The only functional way to accomplish this is with a depressed stock price. However, if I am Liberty Media, and I have already taken care of item "A" above, my goal is to get the most possible money for the fewest number of shares I am selling back. That way I will get not only get my initial investment back, but a healthy premium as well.
Consider if an average buyback that Liberty Media participated in was $4 per share. It would eliminate just 176,500,000 shares out of the 706,000,000 that are high basis. Liberty Media would then have 529,500,000 remaining shares to sell into buyback programs. This is the precise reason that an event such as a Reverse Morris Trust is 2 to 4 years away. Essentially, Sirius XM has to buy back almost 1.8 billion shares before Liberty would do the spin. This is where debt, free cash flow, and an increasing EBITDA come into play.
Currently, inclusive of the credit facility, Sirius XM has debt of about $3.7 billion. For argument's sake, the company can currently afford to borrow another $700 million and still maintain a 4 to 1 debt to EBITDA ratio. If 2014 has an EBITDA of $1.4 billion that would allow for another debt issue of $1.2 billion. In total, the company could have about $3.2 billion in borrowed money combined with $1.5 billion in free cash flow to buy back shares over the next 2 years. That equates to buying power of $4.7 billion. At an average buyback price of $4 it would be enough to take care of all of the Liberty Media High basis shares, as well as keep Liberty Media above 50% ownership. Any shares bought back at a price above $4 per share would push out the time line for Liberty to divest itself of high basis shares.
This is why the company may want a depressed price until such time that the dilutive impact of options and convertibles is played out. That is not to say that the company will intentionally deflate the stock price, but rather it is looking at this functionally by what works best for the majority holder in a "perfect world". After that is done, the only reason that a depressed price desire would be an issue is because buybacks are happening in part with borrowed money. Aside from the borrowed aspect, all sides would theoretically align in a desire to see a big price appreciation. If the stock price is accelerating rapidly, it could actually serve to extend out a spin or Reverse Morris Trust until a later date because it would take longer to buy out the remaining Liberty high basis shares. In my opinion the biggest benefits in terms of share price for Sirius XM happen after the first 300 million shares or so are bought back. It is only after the dilutive impacts of options and convertibles are erased for all parties that the proverbial stars align and true and meaningful stock price appreciation happens.
Bear in mind that these dynamics assume a reasonable continued growth for Sirius XM. If growth is faster then borrowing power happens faster. If growth slows, so does timing on borrowing power. This stock buyback is a double edged sword. It actually has longer term holders in hopes that the price stays flatter until after the initial buyback is complete. Stay Tuned.