- Liberty Media removes offer for Sirius XM equity swap.
- Short-term turbulence expected as arbitrageurs unwind.
- Removal of deal very positive for both equities.
I don't often get into short-term speculation. I prefer looking out a year, taking a position, and riding the ups and downs towards my target. While it may be fun here and there to guess those little short-term undulations, the fact of the matter is that they are generally unpredictable.
To put things plainly, you can lose your shirt (and your pants, and your sanity) in rapid succession on a wrong call.
It wasn't all that unexpected
Tonight Liberty Media (NASDAQ:LMCA) released news that should not have been unexpected by many who have been reading my articles. Its offer of an equity swap for the remaining shares of Sirius XM (NASDAQ:SIRI) it did not control, is now off the table.
As a result of the change, Liberty says its previous offer for Sirius XM is "no longer applicable." The company adds it remains an "enthusiastic" owner of 53% of Sirius.
Readers will remember I have been saying for some time now that this 'deal' of sorts did not have to happen, and was even unlikely to happen. Certainly I did not expect it to happen at the ratio offered.
I am not convinced there is that much benefit to Liberty in this deal, and because of that I do not expect Liberty to offer that much of a premium. Current Liberty holders, in my opinion, would be unlikely to agree to a 0.091 ratio, and Sirius XM investors, in my opinion, would be unlikely to agree to anything less.
The fact of the matter is that the offer was made at a very opportunistic time for Liberty Media. Sirius XM had suffered recent weakness that was not mirrored in Liberty's share price, despite Liberty's market cap being made up in great majority by its stake in Sirius XM. Basically, there was a disconnect, and Liberty rightfully took advantage of the disconnect with what many Sirius XM holders recognized as a low ball offer.
What happened after Liberty's offer was a learning experience for me in the world of arbitrageurs (arbs) which are defined as :
A type of investor who attempts to profit from price inefficiencies in the market by making simultaneous trades that offset each other and capturing risk-free profits.
I am not so sure I agree with the "risk-free" part in all cases, though.
Many Sirius XM investors, including yours truly, expected a sweetening of the ratio offer. If a deal was to be made, and the ratio offered was improved in Sirius XM's favor, holders of Sirius XM would have received more of Liberty Media in the swap.
This created an opportunity for those who wished to play on these expectations. The play for the arbs? Buy or cover Sirius XM and sell or short Liberty Media. This becomes quite obvious when one looks at the short interest for both companies, Sirius XM and Liberty, after the offer was made. Short interest data taken from Nasdaq listings for Sirius XM here, and Liberty Media here.
This should be clear. The original offer was made early January, and in that time you can easily see the play in action. Liberty Media's short interest tripled and eventually quadrupled, while Sirius XM's short interest dropped to levels that I do not believe I have ever seen in the last several years.
That play is now poison, bad, wrong, or whatever one wishes to call it. With the deal removed, the equities are now free to trade in decoupled fashion, and the holders of those positions are backed into a corner and likely looking to exit post haste.
What does this mean in the short term? Since Liberty is shorted or sold, covering creates buying pressure. It is highly likely that Liberty Media's share price receives a rapid upward bump on Friday at the very least. After-market prices in Liberty support this with the equity up by roughly $4.
Sirius XM? Because this would have been the long side of the play, an unwinding should result in significant selling. Downward pressure? After-market trading Thursday has shown that Sirius XM shaved 8 cents from its closing price, or a little over 2% on the news.
My personal take on all of this? Short-term volatility should abound with a return to the norm after these plays are unwound. Because Sirius XM is currently trading at or very near to the low end of where it has historically traded on an EV/EBITDA scale, there may be buyers here to grab what could be perceived as a quick fire sale of shares by 'traders' and not 'investors.'
Something doesn't make sense?
If you've read this far, you may be asking why shares of Sirius XM did not go up due to these traders both covering shorts and going long Sirius XM. Two reasons can be offered as possible. The first is that Liberty's offer locked Sirius XM to Liberty's share price. With Liberty under heavy selling and shorting by the arbs, Sirius XM's share price had no choice but to follow Liberty's down in tandem.
Another reason, and one which is an assumption based on my observation of the internet chatter in this time frame, is that many longs took the deal as a cue to 'dump and run' from Sirius XM. I received significant numbers of comments and messages in this time frame that very long-term holders were now selling at these share prices because they felt the deal as offered was offensive, or they did not want to be a part of what they guessed were John Malone's plans for a cable empire, or that they did not want to hold Liberty shares or did not wish to research Liberty and all the companies under that umbrella. Some were just worn out from a dragging share price over the past 6 months.
This is rather important, in my opinion, because these comments and messages come from individuals who claim to have significant stakes. Some claimed to hold hundreds of thousands of shares. An outpouring of longer term investors with sizeable stakes can provide the volume necessary for the short covering and the long positions of the arbs.
Short-term volatility breeds opportunity
While I cannot predict with certainty what the short term will hold for Sirius XM or Liberty Media, it is reasonable to make the assumption that Liberty will face respectable buying pressure and Sirius XM similar selling pressure.
The question in my mind is, what happens once the arbs are out? For my investment in Sirius XM, I have to look at my own expectations of valuation, and my own expectations of company performance through 2014.
I will put this bluntly. If there is a quick drop in share price, I am certainly not a seller at this level. Unfortunately, I am personally not in a position to buy. That being said, if I were an investor who had recently sold out because of the deal and in cash or something else, I'd be jumping for joy. I would have sold high and may have a very good buying opportunity in the next day or two picking up shares from arbs unwinding their positions. I have already received several indications that some who recently sold are ready to get back in.
Sirius XM is free again to trade on its own merits, and investors should remember that this means a very large purchase and retiring of the remaining shares left in its agreement to buy back shares from Liberty Media. It also means the ability to return to an authorization to buy back billions of dollars worth of shares from the open market that has been on hold for some time now. I see the removal of this deal as a very big weight being removed from Sirius XM's share price, and longer term I feel those who buy at or near these levels subject themselves to the possibility for rather exceptional gains going forward. Think back to how $1.27 looked in 2011, or $1.80 looked in 2012. I believe current pricing will look in the future, like those prices look to investors today. "If only I had known then what I know now," right?
Liberty Media investors, I'm not leaving you out of this either. What's good for Sirius XM's share price remains as good for Liberty Media's share price. That, coupled with what should be significant short covering, should translate into exceptional gains for Liberty holders over the coming year and even in the short term as well.
Friday's trading will be telling.
Additional disclosure: I am long SIRI January 2015 $2.50, $3 and $3.50 calls in decreasing amounts.