While investors are aware that Sirius XM Radio (SIRI) is in the midst of a $2 billion share buyback, what is less well understood is the total number of potential Sirius XM shares that overhangs the market. Popular misconceptions are that the total potential shares are the same as the diluted share count used in the earnings report. However, a closer examination shows flaws in using these numbers.
Looking at the first quarter 10-Q one can find the following numbers:
- 6,606,276,000 -- The diluted weighted average common shares outstanding. Since this is a weighted average, it includes 1) a portion of the 157,183,759 shares that have been repurchased, 2) a portion of 7,195,28 shares issued through the exercise of options and vesting of restricted stock units, and 3) a portion of 27,687,850 that have been issued to certain holders of the 7% Exchangeable Notes (the Notes). It also includes certain stock options that could be exercised at a gain (using the treasury method of accounting), but excludes the shares underlying the remaining Notes.
- 6,442,718,811 -- Shares issued as of March 31, 2013. This excludes shares underlying the remaining Notes as well as certain options that are both exercisable and in the money. It also includes 9,070,276 shares of Treasury Stock.
- 6,433,648,535 -- Shares outstanding, at March 31, 2013. This excludes 9,070,276 shares of Treasury Stock.
Furthermore, the 10-Q includes the following information (000s omitted):
Weighted average common shares outstanding for basic net income per common share
Weighted average impact of assumed Series B Preferred Stock conversion
Weighted average impact of other dilutive equity instruments
Weighted average shares for diluted net income per common share
The first two lines reflect the conversion of Liberty Media's (LMCA) preferred shares that took place in January when Liberty took hard control of Sirius XM and replaced certain directors. From a diluted sharecount perspective, the movement of shares from the second line to the first line was to comply with accounting rules. The second line will remain in future reports, although since it represents only a portion of January it will continue to decline over time and has no significant impact on diluted EPS or diluted shares outstanding.
Of more significance is the relatively small number on the third line. This is related to the remaining Notes and certain stock options and/or restricted stock units. The 10-Q states:
Common stock equivalents of approximately 349,681,000 ... for the three months ended ... March 31, 2013 ... were excluded from the calculation of diluted net income per common share as the effect would have been anti-dilutive.
Quite frankly, I was surprised that nearly 350 million shares were excluded. After all, the company still has $502.37 million of Notes outstanding that can be converted to common stock at the rate of $1.841 per share. That's nearly 273 million shares. And with the shares trading above $3 at the end of Q1, and the company earning a profit, it seemed that these shares would be included in the diluted share count.
So why would the inclusion of these "shares" be "anti-dilutive"? It turns out that the bonds carry an interest cost of nearly $8.8 million dollars for the quarter. If the Notes are assumed to be converted, the $8.8 million ($5.4 million after taxes) in interest expense goes away and the income for diluted income calculation increases from $123.6 to $129.0 million. And, after ncluding the additional 273 million shares in the denominator, there would actually be an increase in the EPS by a few thousandths of a penny.
There are other aspects to dilution with respect to stock options that tend to understate the dilutive effects of stock options on the actual sharecount, although they would be small relative to the 273 million shares from the Notes. The treasury method typically takes director and employee vested options (included in the 87,771,000 "other dilutive equity instruments" in the above table) with an exercise price below the market price at the end of the quarter, assumes they are exercised, and that the exercise price proceeds are used to buy shares at the market price.
The Total Shares?
What should be of interest to investors is how many shares are currently outstanding and how many other shares are likely to become part of the outstanding sharecount? Unfortunately, it is a moving target and is dependent on a variety of factors, including the vesting and exercise price of options, current and future share price, vesting of restricted stock. future option grants and the disposition of the Notes. It is also dependent on the number of shares already repurchased.
Investors already know that there were 157,183,759 shares repurchased in the first quarter and that the number had swollen "to approximately 209 million shares" by the Friday before the earnings conference call. We also know that there will be another 273 million shares from the Notes within the next 18 months. Starting with the 6,442,718,811 -- or 6,442.7 million -- at the end of the first quarter, subtracting the additional 51.8 million shares purchased during April, and adding the 273 million shares from the Notes generates a total of 6,663.9 million shares. It is also possible that there have been additional share repurchases since April. Finally, there were several million options that were exercised and sold and it is probable that additional options have vested.
As of the date of the conference call, the company had "over 1.3 billion of remaining capacity under our share buyback authorization." And considering that the share price after the conference call has averaged about $3.50, the company has the capacity to purchase approximately 370 million additional shares under the current buyback plan. Considering the hypothetical 6,663.9 million sharecount calculated above, an additional purchase of 370 million shares leaves the company with nearly 6.3 billion shares at year-end 2014.
Clearly, the company has no intention of stopping share repurchases once the $2 billion limit has been reached. It should also be clear that the company will have a very difficult time shrinking the share count significantly anytime soon. As recently as January, at the Citi Global Internet, Media and Telecommunications Conference, Sirius XM CFO David Frear discussed the share buyback and its impact on free cash flow per share. At the time he suggested that the current buyback would reduce the sharecount by 10%, or 600 million shares. The 600 million shares that he may have thought was a conservative projection, now appears unobtainable unless the share price declines. And reducing sharecount by 10% looks even less obtainable.
If the share reduction is going to be difficult, the growth in free cash flow per share -- a metric that is important to many analysts -- may also be less than anticipated.
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.