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Earlier this week Liberty Media (NASDAQ:LMCA) announced that it would be making a sizable investment in cable company Charter Communications (NASDAQ:CHTR). The investment is:

...to acquire approximately 26.9 million shares and approximately 1.1 million warrants in Charter Communications, Inc. for approximately $2.617 billion, which represents an approximate 27.3% beneficial ownership in Charter and a price per share of $95.50. Liberty expects to fund the purchase with a combination of cash on hand and new loan arrangements.

The transaction is expected to close within the next two months. The agreement limits Liberty's stake and allows Liberty to appoint four members to the Charter Board of Directors. Liberty announced that those four would be Liberty Chairman John Malone, Liberty CEO Greg Maffei, Barnes & Noble (NYSE:BKS) CFO Michael Huseby, and Liberty Global EVP and CTO Nair Balan.

Despite the equity limitations, an article at nytimes.com begins, "John C. Malone has slipped through the door again." and concludes:

Though Charter's chief executive, Thomas M. Rutledge, welcomed Mr. Malone to the table, he also tried to give the house an edge. Liberty Media, Malone's holding company, can't increase its stake in Charter above 35 percent until January 2016 and after that is capped at just under 40 percent. Mr. Rutledge may hope that despite Malone's four board seats at Charter, one of which he will fill personally, the ownership restrictions will keep his new investor under control.

Smart money attuned to Mr. Malone's dealings should assume he's already thinking about ways around them.

Charter isn't the only recent investment by Liberty. On March 12th it increased its stake in Live Nation Entertainment (NYSE:LYV), purchasing an additional 1.7 million shares at $11.40/share. It now owns approximately 52 million shares, or nearly 28%, of Live Nation. So, what does all this have to do with Sirius XM Radio (NASDAQ:SIRI)?

The Sirius XM Share Buyback

As most investors in Sirius XM know, Liberty Media took control of the company earlier this year after receiving approval by the Federal Communications Commission ("FCC") and inserted its own Board of Directors at Sirius XM. These investors also know that despite Sirius XM having authorized a share buyback on December 6th, no shares had been purchased as of the year end earnings release on February 5th, when Sirius XM CFO David Frear stated:

When we announced the program in December, we were pretty close to earnings. And so the advice we had was to stay out of the market until we had gotten kind of the material nonpublic information into the marketplace, which I think we effectively do with this call and getting the K filed.

Investors won't know whether or not Sirius XM has begun the buyback until the company releases its Q1 earnings in May. As of now, both the share volume and the stagnant price suggest that it still may not have begun. On February 5th, the date that Frear made his comment, shares traded between $3.11 and $3.21. Since then, the shares have traded from a low of $2.97 to a high of $3.25. And, the average daily volume of 55 million shares over the past 3 months indicates the trading volume has declined slightly since February 5th.

If Sirius XM has been actively buying back stock, it hasn't had much of an impact on the share price or the trading volume. And, if the buyback has not yet begun, why not? Liberty is the one controlling the buyback at this point, and it may not yet be ready.

Liberty completed its first purchase for 60 million shares in May of last year, and announced its first forward contract at that time. That forward for 302 million shares would not close until two months later. Liberty also entered a second forward contract and began purchasing more shares on the open market in August. Those shares all have significant capital gains at this time, but will not be eligible for the reduced long-term capital gains tax until their one year anniversaries arrive. It's certainly possible Liberty has been waiting for that one year anniversary before allowing the buyback to begin.

Cash is King

On Liberty's recent conference call, CFO Chris Shean disclosed that Liberty had sold its stake in Sprint (NYSE:S) and decreased its holdings in Viacom (NASDAQ:VIAB) and Time Warner (NYSE:TWC). Liberty still holds equity stakes in a variety of companies, and selling these stakes could be used to raise additional funds to be used to increase its investment in Charter to the 35% and 39.99% levels. It could also use some cash to continue building its stake in Live Nation or pursuing other investment alternatives.

The largest source of that cash could come from selling off its 705.8 million high cost basis shares in Sirius XM, currently worth almost $2.2 billion. There are two complications. As noted above, there is a large capital gain in these shares. According to Liberty's Form 4's and 13D filings, it paid just over $2.34/share for these purchases - nearly $1.6 billion. That's a taxable gain of more than $0.6 billion that can be slashed by waiting for the one year anniversaries of these purchases to arrive.

Liberty Plans for Sirius XM

What does Liberty plan to do with its stake in Sirius XM? Maffei made several statements during Liberty's Q2 earnings conference call. First, he stated:

I think a consideration in our mind would be, and obviously we have announced no intent to do a Reverse Morris Trust. We've only suggested its one path. But I would note, if we pursued that path, something that would weigh on our mind is, we got the first 40% of the company for free virtually. The next 11 points have cost us well over $1 billion something if we got to 51. We would probably like to get the bait back on the 11 points.

and he subsequently added:

We've noted that there is flexibility in the capital structure at Sirius, there's plenty of availability for them over the next short term to lever further and return capital to shareholders including ourselves, and whatever we did, we would be unlikely to want to spin out high basis stock, we'd probably given how much we've already shrunk Liberty Media over the last several years...we'd probably be wanting to get that cash back. So, that would be the biggest consideration in our minds, a major one.

As I noted earlier, there were two complications. In addition to the capital gains issue, there is an issue of retaining a majority position to take advantage of the tax favored treatment of spinning the shares with a Reverse Morris Trust or RMT. The majority position only needs to exist at the time of the RMT, and Liberty could let its ownership level fall below 50% in the interim. In fact, unless Sirius XM has already begun its buyback program, Liberty's ownership percentage of Sirius XM declined slightly when some owners of the 7% Exchangeable Notes took advantage of the enhanced share exchange recently.

As a result of Liberty taking control of Sirius XM with its 50 million share purchase on January 15th, the holders of these Notes were offered 38.138 additional shares for each Note. Less than 9% of the Note owners accepted the offer, but it did result in the issuance of 27,687,850 new shares of Common Stock. (There has also been some additional dilution since Liberty took control as a result of exercise of options.)

There is still $502.37 million worth of these Notes outstanding, convertible into 543.1732 shares for each Note, or nearly 273 million shares. (Liberty holds $11 million of these Notes, convertible to 6 million shares.) Does Liberty need to be concerned about these Notes or other dilutive equity instruments? Yes, but not until it is ready to proceed with the RMT. The reason there would be no immediate concern is that Liberty should easily be able to maintain control of the Sirius XM board, even if its ownership falls into the high 40% range.

Summary

It's possible that the Sirius XM share buyback has not yet begun. The comparatively low level of share volume and the lack of movement on the stock price seem to support this view. And, if Liberty is looking to rebuild its cash position, it could be waiting for the one-year anniversaries of its purchases before directing Sirius to begin share buybacks.

Liberty's investments in Sirius XM have performed remarkably well. Malone and Maffei are willing to drive up leverage at Sirius XM and could already be arranging a significant increase in debt. In addition, the remaining $502 million of Notes will mature in December of 2014, and with those Notes likely to be redeemed for shares, there is additional opportunity to take on more debt as refinancing at rates lower than the 7% coupon should be available.

To the extent that Liberty wants to increase its stake in Charter, Live Nation or other investment opportunities, their largest source of cash could come from participating in a Sirius XM share buyback - a buyback that may not begin to heat up until the one year anniversaries of its purchases occur later this year.

Source: Why Liberty Media Will Sell Its Sirius XM Shares

Additional disclosure: In addition to my long positions, I have January 2014 $3.50 covered calls written against many of my long positions in Sirius XM. I also trade blocks of Sirius XM on a regular basis.