Is Sirius XM's (SIRI) buyback "terrible?"
Apparently, Timothy Green thinks so. In an article recently published over at The Motley Fool, Mr. Green highlights his opinion of why Sirius XM's stated $2 billion buyback plan is, according to the definition of terrible, a very very bad thing.
He prefaces with:
"Let's look at three companies that have genuinely terrible buyback programs."
And goes on to discuss Sirius XM among two other companies in the article:
Are you Sirius?
Sirius, the satellite radio company, has a different problem that Chipotle. In December Sirius announced a $2 billion buyback program to the glee of many Sirius investors. But does it make any sense? Will it actually be good for shareholders? No, it doesn't and it won't.
Sirius is funding this buyback through cash on hand, the free cash flow, and taking out more debt. At the end of the first quarter Sirius had about $200 million in cash after spending $466 million on buybacks. The debt totaled $2.18 billion, on which Sirius paid $265 million of interest in 2012. Free cash flow in 2012 was $700 million, but Sirius paid no taxes due to a huge tax benefit. Sirius will need to take out more debt to complete the buyback, which is a seriously terrible idea.
Sirius' free cash flow per share is about $0.10. With a share price of about $3.50 the stock trades at 35 times the free cash flow, and that doesn't even factor in the debt. The message that Sirius is sending with the buyback is that buying its shares at 35 times FCF is a better investment than reducing its debt. The effective interest rate on that debt in 2012 was just shy of 10%, so it seems like a far better use of its cash and cash flow would be to pay off the debt instead of taking out more to buy back shares. If the company used the next three years worth of free cash flow to eliminate the debt it would increase profits considerably. This seems a lot more shareholder-friendly to me.
If a company takes out debt to fund a buyback, the stock better be seriously underpriced. This is not the case with Sirius, making the massive $2 billion buyback program a terrible idea.
So is Timothy correct? Should Sirius XM give up on its share repurchase program and instead use the capital to pay down debt, as he has, literally, boldly stated?
No, not really, and I am not even sure Timothy understands a critical issue here. If he had done a quick bit of research, he would understand that Sirius XM has refinanced and paid off what high interest debt issues it could. The remaining debt? It has restrictions, can't be called early (such as the debt tied to the convertible bonds) and therefore it is impossible for Sirius XM to use this capital to repay the high interest issues.
The recent debt taken on by the company? Under 5%. To be specific 4.25% and 4.65% respectively on $500 million per debt issue. Certainly manageable, and unless you believe the company's market cap will not grow by 5% or more per year, then using this debt to buy back shares is an effective use of capital.
Consider the explanation I offered where I show how repurchasing shares now should pay off big down the road:
How does one turn $5 billion into $8.75 billion over 5 years? With an investment that returns approximately 12% over that 5 year period, that's how. And that is roughly (and conservatively) what I expect Sirius XM to achieve with its buyback plan. So how do I arrive at this number?
First, it's important to understand that when a company buys back its own shares, it is essentially investing in itself. By taking cash, or by taking on debt, and buying back its own shares it is saying that it expects the company to perform well enough that the return on capital will exceed the expense of that capital. In the case of cash, the return can simply be viewed as the company's appreciation moving forward. In the case of debt, the return is a bit more complex...
...But, if Sirius XM borrows that future cash now to buy back shares, it receives the benefit of the underlying appreciation of the company on that $5 billion bought back. Using the equation above, $5 billion turns into nearly $8.75 billion in about 5 years. That $3.75 billion extra gets rolled into the market cap of the company, and investors should realize that amount of additional appreciation, which is nearly 19% increased appreciation from today's market cap. Instead of 100% return in 5 years, investors should see 119% return in 5 years. That's a nice little bonus.
Sirius XM's share buyback is not "terrible" at all. Investors who are long and have a longer-term horizon will benefit from current share purchases by the company. Short-term fluctuations in price do not point to mistakes in share repurchase decisions. I would argue that lower short-term pricing only increases the potency of the buyback, as it allows the company to buy back more shares for less money.
Additional disclosure: I am long SIRI January 2014 $2, $2.50 and $3 call options.