Let me not be the first to say that Reverse Morris Trusts (RMTs) are complicated. Over a year ago when the Liberty Media (LMCA) plan for a possible RMT with its Sirius XM (SIRI) stock was raised, I did some research to understand what an RMT was and whether it would be good or bad for investors. It was only after reading a lot of papers and articles on the subject that I came to the conclusion that it's not an easy-to-understand concept even for professionals operating in the finance sector. Earlier this week, however, I noticed something that would make an RMT highly beneficial to Sirius XM shareholders, myself included. It is something that I have yet to see mentioned.
As an index manager, I manage the SPADE Defense Index, which is used by InvescoPowershares as the underlying index for their Aerospace & Defense ETF (PPA). As such, I am very familiar with the indexing world. When I looked at the institutional shareholders for Sirius XM, one major thing was missing - Sirius XM is not included in any of the S&P indexes including the S&P 500.
Now, I should point out that S&P Indices are not rules-based, all changes are discretionary and decided upon by the Index Committee, however, they look at five primary criteria when looking for inclusion candidates: trading analysis, liquidity, ownership, fundamental analysis, market capitalization, and sector representation.
With a $20 billion market cap, Sirius XM is certainly large enough to be included, trading in the stock is highly liquid, and options easily trade on it. The firm also has positive net income.
Currently there are two problems:
- From its brochure, "S&P also analyzes a company's stock price history in an effort to minimize the number of single-digit priced stocks in the Indices"; and
- Another factor in making S&P Indices investable is the size of the float available to the public. Standard & Poor's would like to ensure that a sufficient amount of stock is available to investors to replicate the Index. To do this, Standard & Poor's looks for Index candidates that meet the following two conditions: 1) no single entity may hold more than 50% of the outstanding shares, and 2) multiple entities may not hold more than 60% of the outstanding shares. Such entities do not include open- or closed-end mutual funds.
And this is where an RMT would play a beneficial role. When an RMT takes place, the number of shares outstanding can easily be adjusted and a price level would likely be chosen with a split-adjusted price likely in the $30 range. Additionally, when John Malone and Liberty spin off their holdings to their existing shareholders so that it is a tax-free event for them, the majority ownership position would instantly be diversified.
Now could S&P decide to act before an RMT? The committee under its discretionary authority could add Sirius at any time taking into account the size of the Sirius XM's market cap and its liquidity--even with less than 50% being freely traded on the market. However, an RMT could resolve all the aforementioned issues.
If you're asking yourself why is this important from an investor perspective, then you need to recognize that according to S&P, assets invested in products indexed to the S&P 500 total nearly $1 trillion. The largest of these, SPY, has nearly $130 billion in assets by itself.
To estimate how much of this would flow into Sirius, we look at two companies of comparable size to Sirius XM in terms of market cap - BB&T (BBT), a bank, and the energy firm, Noble Energy (NBL). The list of top mutual fund shareholders in these two companies lists several ETFs that track the S&P500 and these funds hold approximately $500 million of stock in each company. In Sirius terms, this would represent 166 million shares at today's price. Factoring in all the other funds that track the S&P500 and the shares would have to be multiplied by 5.8 (1B/170M), bringing this up to roughly 963 million shares. Purchases from institutional shareholders that track the S&P500 could end up with 20-25% of the company after the planned Sirius share buybacks over the next few years.
In looking at past RMT cases, such as Liberty's spinoff of DirecTV (DTV), usually a sell-off takes place at the time of an RMT as some shareholders decide that now is the time to take profits. Still not all will sell and, as DirecTV was added to various fund portfolio holdings, the share price eventually more than doubled. I expect that Sirius could follow the same path and ultimately those that hold through the initial volatility should anticipate a rebound in price as mutual funds, exchange traded funds, and other professional money managers add Sirius XM to their portfolio holdings. Although some managers might buy in advance, it would not be in large numbers. Guidelines for funds that passively track an index, such as the S&P500, can only own shares of companies that are in that index. So until Sirius meets the rules for inclusion or the S&P committee decides to add it, it cannot be bought by these passive funds.
For example, as an Index manager regardless of what I personally think of SIRI as an investable opportunity (and as a shareholder I obviously think it's going higher) I cannot add it to our defense index because it misses one of our rules, namely it is not a defense company and its operations do not benefit the defense sector. Similarly a fund that tracks the S&P index cannot include Sirius XM until S&P decides the firm meets all of its qualification rules. This is what separates a passive index/fund from an active index/fund; active implies there is a manager who has the flexibility to make individual decisions on individual positions whereas a passive fund tracks an underlying index.
So for those worried about a complete sell-off after Liberty divests their Sirius holdings via an RMT, the likely answer is that, long-term, it could be beneficial for the stock to be something that everyone can invest in than something that everyone cannot.