Sirius XM: Is There Any Reason For Liberty To Sell?

Jul.17.13 | About: Sirius XM (SIRI)

A question that I see come up often with regards to Sirius XM (NASDAQ:SIRI) was posed today on a recent article by Seeking Alpha author Spencer Osborne. Simply stated; Is there any reason for Liberty Media (NASDAQ:LMCA) to sell its Sirius XM stake, and if so, who might a buyer be?

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It's a great question and due to the frequency with which it comes up I thought it might be a good idea to expand upon my brief answer to Last Lap Rich.

First, I believe it is well understood that Sirius XM makes up the greatest portion of Liberty Media's market cap. As I stated last year, if you consider Liberty Media to be a "burger" of a company then Sirius XM is the actual meat. It's the priciest and arguably most essential portion of the company. Take anything else away such as Liberty's holdings in Live Nation (NYSE:LYV) or Barnes and Noble (NYSE:BKS) and you impact the company's market cap slightly. If you take away Sirius XM the market cap of Liberty Media would likely be reduced by greater than half.

A burger is a burger by itself, with all the other parts removed. A burger without the burger patty turns into something else. Arguably a lettuce sandwich with pickles, tomatoes, mayo and no meat does not sound as appetizing and would likely command a much lower price. When I think of the stock market I think of ravenous meat eating carnivores anyways. Vegetarians? Not so much. Meat is good when it comes to investing.

That said, once it is understood that Sirius XM makes up that all important meat of Liberty Media, it can be seen how important this is to Liberty's moves. Consider how Liberty uses its Sirius XM stake. It is using it as leverage to back margin loans when it needs cash for other ventures. By holding on to Sirius XM and borrowing against it, Liberty is able to borrow at low rates on an asset which is increasing in value at a much greater rate than the borrowing costs.

That's the key here as to whether or not Liberty will be in a hurry to sell back its shares or spin out the company in a Reverse Morris Trust. So long as Sirius XM is projected to increase in value to a much greater extent than it costs to borrow against that stake then it is likely Liberty will be more inclined to hold its position and not sell its shares, be they high basis or low basis.

Consider someone with $1,000,000 in something valuable that is expected to increase in value by 30% in the coming year. Let's call it "gold." Now consider that person needs $200,000 in cash to pursue some sort of venture. They can borrow this against their stake in "gold" at 5%. At the end of the year if they borrow against their stake they pay $10,000 in interest but the underlying asset increases in value by $60,000. They made $50,000 vs. selling that "gold" and using cash to fund the transaction.

Of course there are risks involved here. If "gold" (Sirius XM) depreciates then the individual (Liberty Media) would be better served using cash and not holding that depreciating asset and paying interest. The beauty here is that Sirius XM has the free cash flow and borrowing capacity to add debt and repurchase some of those high basis shares from Liberty if Liberty needs cash. If interest rates go up enough, or if Sirius XM slows in growth and the share price stagnates, Liberty could choose to begin selling back at that time.

But for now, Liberty is best served by holding on to its entire Sirius XM stake and doing the same thing it has been doing this year. Taking margin loans against its stake in Sirius XM at low interest rates, especially as Sirius XM is steadily appreciating due to company performance on top of share buybacks, is a smart move which should be quite beneficial to Liberty Media and Sirius XM both. On Liberty's side, investors get cheap leverage at favorable interest rates on top of Sirius XM's appreciation. On Sirius XM's side investors get stability and the benefit of a long supportive buyback rather than a quick and dangerous pump an dump from Liberty Media.

The question of who might a buyer be if Liberty were to sell I feel is best answered with "nobody." At the moment I don't see other companies out there as being interested in purchasing Sirius XM, and if and when the time comes for Liberty to spin out its Sirius XM stake I would expect it to spin Sirius XM out as Sirius XM. Time could change my perception here but for now I don't see Sirius XM being sold.

In my opinion, investment in either company, Sirius XM or Liberty Media, will do extraordinarily well. Both are excellent investments. Whether you buy one or the other or both will depend on your perception of the other companies in the Liberty Portfolio or whether you prefer the "pure play" Sirius XM provides on its performance alone.

Disclosure: I am long SIRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long SIRI January 2014 $2, $2.50, $3 and $3.50 calls capped at $4 in a series of bull call spreads.