Sirius XM Radio's (SIRI) recent announcement that it would retire $539.6 million of its 7.625% debt due 2018 appears likely to result in a charge in the fourth quarter that will approach $70 million. The charge will be comprised mostly of a "Make Whole" provision in the bond indenture.
For those unfamiliar with this type of provision, its purpose is to afford some protection to bond-holders who may have to reinvest funds in a lower interest rate environment. Keep in mind that many bond investors are looking for a stream of regular future payments to meet their future obligations. These investors are not looking for capital appreciation.
The make whole provision of these 7.625% notes is:
At any time prior to November 1, 2014, the Company, at its option, may redeem all, or from time to time, any part of the Notes ... at a redemption price (" Make Whole Redemption Price ") equal to the greater of the following amounts:
(1) 100% of the principal amount of the Notes then outstanding to be so redeemed; and
(2) the present value of the sum of the redemption price of the Notes at November 1, 2014 (such redemption price being set forth in the table in Section 3.06(d)) and the remaining scheduled payments of interest on the Notes to be redeemed, to, but excluding, November 1, 2014, discounted to the applicable redemption date in accordance with customary market practice on a semi-annual basis at a rate equal to the sum of the Treasury Rate plus 0.50%;
plus, ... accrued and unpaid interest, if any, on the principal amount being redeemed to the applicable redemption date.
The November 1, 2014 redemption price referenced above is 103.813% of the face amount. In order to calculate the total payments (and ignoring the interest payment due November 1, 2013 since this would have been taking place in the fourth quarter without the redemption) one needs to determine the present value of the two interest payments due on May 1 and November 1 of 2014, as well as the present value of the 103.813% of the note's face amount.
According to Wall Street Journal, the yield on six month T-Bills is 0.035% and the yield on one year Treasury Notes is approximately 0.14%. These yields will result in small discount factors, even with the 0.50% adder, of approximately 0.997 and 0.994, respectively. These small discount factors mean that the payouts made in Q4 will be quite close to the payouts that would have been made by waiting until 2014 to make the redemptions.
Cost of Redemption
Considering the Note holders are entitled to a 30-60 day notification, and using a redemption date of November 1, 2013 the total cash cost to redeem the $539.6 million of notes outstanding would be approximately $597 million, plus fees. Using a 1% fee would bring the total cash cost to $602 million. The difference between the $602 million and $539.6 million, or $62.4 million would be recorded as a loss on extinguishment of debt during the fourth quarter.
In addition to the cash cost, Sirius XM would need to write down the remaining discount on the notes. There were originally $700 million of these notes issued in 2010 at a total discount of more than $12 million. As of the end of the second quarter, the 10Q showed there was still a balance of $7.7 million of unamortized discount remaining on $599.4 million of notes outstanding.
Obviously, during the third quarter, Sirius XM redeemed another $60 million of these notes. I estimate that the remaining unamortized discount that would need to be written off in the fourth quarter would be approximately $6.7 million. The total of $6.7 million plus the extra $62.4 million cash cost would equal a $69.1 million charge in Q4.
These 7.625% notes now being redeemed were issued just three years ago to redeem the 11.25% debt of XM. Sirius XM has been incurring significant amounts of early redemption fees during the past 15 months to clean up the old debt. Other than the 7% Exchangeable Notes that cannot be called, the 7.625% notes are the last of Sirius XM's older debt, often referred to as toxic debt.
For quite some time, Sirius XM has been discussing net leverage targets of 3.5x with much of the new debt to be used to fund share buybacks. The process of cleaning up the balance sheet should pave the way for Sirius XM to once again return to the debt markets, receive favorable rates and expand the share buyback program.