It is not often that situations come about where no matter the outcome, those who place their bets on a certain side will win. I'm of the opinion that this is exactly the case with the long side of Sirius XM (NASDAQ:SIRI) over the longer-term period.
Note, by longer term I am looking 1 year or more out. That will be important to remember going forward. If one has a short-term horizon, impatience, or keeps peeking over the fence at Tesla (NASDAQ:TSLA) with envy, then holding on to or entering into a position in Sirius XM will probably be more frustration than it is worth. If you are the type of investor who is not satisfied with a 20% annual gain, and believe you can rake in 50% and beyond year after year, then again, a long Sirius XM position will disappoint you.
Many investors in both Sirius XM and / or Liberty Media (NASDAQ:LMCA) are aware of the current offer by Liberty to swap equity in Liberty for the remaining shares of Sirius XM that Liberty does not own. There is ample information on this proposed swap out there so I won't repeat it all here. I'm going to attempt to take a complex situation and make it as simple as possible.
Take the deal off the table
If one takes the deal off the table, are current share prices where one would expect Sirius XM to be? In my opinion, no. I find Sirius XM to currently be trading at the lower end of fair value or even slightly under. It's a pretty strong buy here on its own, and one can read my article history to understand why. After what I would consider to be a 'confusing' quarter to most in Q3 of 2013, Sirius XM's share price suffered from the $4 area to the low $3's. Slowing growth was cited as one of the main issues, and I received many messages since that very long-time holders had sold out and that many short-term holders had bailed or even shorted the stock. Confusion and selling pressure is generally not a recipe for increasing prices.
Q3 coupled with Q4 was not bad, though. An EPS 'miss' due to elimination of some old high-rate debt? Future positive, even if it appears as a short-term negative on the surface. Several analyst downgrades? That's all well and good, but exploration of who added and who decreased positions in Sirius XM since, show that downgrades were met with bolstered positions. That might leave you scratching your head, but I wouldn't be surprised if it doesn't. When Goldman Sachs downgraded Sirius XM I suggested readers watch to see if it added to position in Sirius XM during the quarter during the weakness. They did. Morgan Stanley added as well, despite a target below current share pricing.
The fact of the matter is that Sirius XM has not underperformed. It has performed. Sirius XM has not exceeded my expectations, it has reasonably met them. Future guidance by the company, I expect, continues to be cautious and conservative and falls within the realm of expectation as well. Therefore, I see little reason to either discount or raise the bar for Sirius XM on its own merits. At $3.60 per share, I believe this represents a significant discount to my expected valuation of share price which should currently sit North of $4 per share, and approach $5 per share by early 2015.
Such a target assumes that Sirius XM takes its current authorized buyback to completion and completes its purchase, and retiring, of shares it has agreed to purchase from Liberty Media. Holders of Sirius XM and Liberty already know that this block of shares is on hold while 'the deal' is negotiated.
This gives me expected appreciation of about 39% year over year from present levels, assuming Sirius XM performs on a stand-alone basis separate from Liberty Media. If Liberty's offer is completely rejected, I expect that Sirius XM will return to an appropriate share price level, especially since Sirius XM will no longer be tethered in price based on a ratio to the value of Liberty class A shares.
I view the rejection of a deal as both a short-term and a long-term victory for Sirius XM share holders.
Place the deal back on the table
If the deal goes through, it is reasonable to expect it will go through in modified form. Negotiations typically result in the acquirer increasing its offer at some point either in minor or major fashion, and in the case of this deal I see a minor adjustment to the proposed ratio as reasonable to expect if a deal is put to a vote. If the ratio is improved slightly it is important to note that unless the share price of Liberty Media improves quickly in the short term, then Sirius XM shareholders instantly lose some value.
This is critical to understand. Based upon the share prices of the two companies and the ratio offered for the remaining shares of Sirius XM, the current offer discounts Sirius XM shares below where those shares are trading at today. If you want a reason to vote "NO!", that's probably all you need to understand. You can listen to a bunch of baloney about how the longer-term future prospects of this deal would be good over the next several years for Liberty Media (and if the deal goes through, the future you as an owner of non-voting Liberty C class shares!) but today, right now, you would surrender a portion of your value for that, umm... 'opportunity?'
Before I go on, I'd like to note that this is the first time I have ever used the term 'stupid' in one of my articles, but I feel so strongly about this that I could not think of a less insulting term to use.
Certainly there are stupid people out there and thus it is reasonable to assume that there are stupid investors, but I find it hard to believe that any right-minded Sirius XM holder would vote this deal as a 'YES!' in present form. If you feel Liberty is undervalued, you will buy Liberty shares and sell Sirius XM today, and thus get more shares of Liberty for less cost. Right? Why would you take a deal that values your shares at less than what those shares are going for in the market?
It's bordering on stupid, then, to put up to a vote an offer which does not have a reasonable chance for success. Because of this, at the very least, I expect the ratio to be improved in Sirius XM's favor to at least a level that places a value on Sirius XM's shares at or above market price. In order for any sort of deal to have any hope of passing it must at least value that which is being acquired at a level that it is trading today.
Make sense? I hope so. That gives Sirius XM somewhat of a short term "put" or downside protection, in that a ratio offer has been made and it is tied to the share price of Liberty Media. While the share price may not appreciate significantly in the short term while details are negotiated, it is reasonable to assume that unless Liberty Media's share price has a sharp decline (and it has already reported for Q4, so events which may cause decline are unlikely), that Sirius XM will remain somewhat stable.
After a deal is offered is when things get tricky. Let's assume that the offer is improved in Sirius XM share holders' favor to a level a few percent above current market price for the equity. This may appear attractive at first glance but there is another point here that is so very critical to understand.
Liberty Media typically trades at a discount to the sum of its parts.
Multiple commenters on various articles have pointed this out. This is not just an idea from my own head.
Liberty holders will often point to Starz (NASDAQ:STRZA) as how Liberty can offer value to long-term holders. Since Liberty was spun out from Starz, Starz has grown near 80% in market cap. Arguably while under the umbrella of the entirety of Liberty Media, Starz was discounted heavily in Liberty's share price.
So what? Why is this a 'problem' for the current Sirius XM holder? Long term it's probably not. If Sirius XM remains within Liberty Media and then is ejected in some fashion on a stand-alone basis, the discounting and then return of value should even itself out.
But what of the intermediate term? Those years that Sirius XM is wholly owned within Liberty? It's reasonable to assume that Sirius XM will be discounted the same way other holdings within Liberty have been. And why is that a problem? Because if you hold Sirius XM and expect Liberty's value to increase in an exact amount proportional to the value of Sirius XM's non-Liberty stake today, you will likely be disappointed. If Starz was discounted by approximately 40% within Liberty, is it not reasonable to assume that Sirius XM will be discounted at a conservative 20%? If you currently hold Sirius XM and it is absorbed into Liberty Media and is then discounted, well, you just lost a big chunk of money on paper.
Let's make it simple with 'rough' numbers. You have $100,000 in Sirius XM at present market price. Liberty's deal is accepted at 5% premium and should = $105,000 resulting value, right? But if the market discounts Sirius XM within Liberty on the transaction by 20% (or worse, more, like Starz 40%) then your resulting value becomes $84,000, or worse.
As a Sirius XM shareholder you do not know if or by how much the market will discount this value, and you do not know how long until, if ever, that value will be spun out and "unlocked" in the future. Will you "win"? Sure. Over time I expect Sirius XM and thus Liberty Media to do well, and I certainly do not expect Liberty to self destruct in the next few years, but it may take a considerable waiting period to recoup that lost value. But the 'event' of the transaction should be a big loss in the near term for Sirius XM holders.
Allow me to be crystal clear. If a deal is put up for a vote and passes for an equity swap, I will very likely completely sell out of Sirius XM before that transaction takes place due to the expectation that the current public portion of Sirius XM will end up discounted while within Liberty Media. Repeatedly I have told readers I would indicate what would drive me to sell my stake in the company. Consider this fair warning. If I am wrong, then no harm, no foul. I'm playing this one as safe as possible, and I can always buy back in afterwards.
Obviously, while I view Sirius XM as a win-win situation, deal or no deal, I certainly find "no deal" to be far more attractive. I am not too keen on waiting years for the value of my shares to be unlocked after an early discount.
What it boils down to is this
I am bullish on future prospects for Sirius XM. Deal or no deal I think investors will do well, but I believe there is a very clear choice here for Sirius XM shareholders, and that is to vote a strong and resounding "NO!" to this deal unless the ratio is increased considerably.
That being said I do NOT expect Liberty Media to increase this ratio considerably. There is no need for Liberty to significantly dilute current holders of Liberty Media to acquire the remaining shares of Sirius XM. There is not enough benefit. I expect that the current deal which has been offered will be retracted after no agreement is reached to be put up for a vote. This deal is wonderful in current form for Liberty shareholders, but quickly becomes horribly sour to Liberty as the ratio is adjusted in Sirius XM share holders' favor.
All of that being said, because I like to keep things as simple as possible, I believe Sirius XM is a relative bargain at current share prices. I believe in an unlikely scenario the deal will be increased in ratio providing a nice short-term bump in share price or in a more likely scenario the deal is taken off the table, and Sirius XM will be allowed to breathe on its own yet again.
Additional disclosure: I am long SIRI January 2015 $2.50 ,$3 and $3.50 calls with the intention of eventually creating spreads with caps at $5.