Sirius XM: A Pawn In John Malone's Cable Chess Match

| About: Sirius XM (SIRI)


John Malone with 10% economic interest firmly controls Liberty Media and Sirius XM.

Also has significant influence at Charter Communications.

Sirius a likely source of funding for increasing Malone's stakes in cable.

It wouldn't seem as though Sirius XM Holdings (NASDAQ:SIRI) would have a lot to do with the world of cable television. However, John Malone, chairman of Liberty Media, has been making waves on both sides of the Atlantic with acquisitions of cable assets in Europe through Liberty Global and the United States through Liberty Media (NASDAQ:LMCA). Liberty is also the majority owner of Sirius, and is firmly controlled by Malone by virtue of his super-voting Liberty Media B shares (OTCQB:LMCB). In a filing late last year it was disclosed that Malone beneficially owned 1,624,011 shares of Series A Common Stock (1.6% of the total A shares) and 9,455,341 shares of Series B Common Stock (95.7%). (The "Issuer" in the following paragraph refers to Liberty.)

Based upon 104,373,984 shares of Series A Common Stock and 9,876,178 shares of Series B Common Stock, in each case, outstanding as of November 30, 2013 based on information provided by the Issuer. At the option of the holder, each share of Series B Common Stock is convertible into one share of Series A Common Stock. Each share of Series B Common Stock is entitled to 10 votes, whereas each share of Series A Common Stock is entitled to one vote. Accordingly, Mr. Malone may be deemed to beneficially own voting equity securities of the Issuer representing approximately 47.3% of the voting power with respect to a general election of directors of the Issuer.

Note that despite having an economic interest of less than 10% - each A or B share has the same economic interest - this layered structure not only puts Malone firmly in control of what occurs at Liberty, but also at Sirius. In a news story published in the Financial Times over the holiday weekend, it was reported that Time Warner Cable (TWC) and Comcast (NASDAQ:CMCSA) were in negotiations to sell

cable assets worth up to $20bn in a deal with Charter Communications that aims to allay Washington's concerns about their proposed merger.

Other news outlets have since picked up the story, although Comcast has not officially confirmed the story.

This latest report could be significant to Sirius investors because Charter (NASDAQ:CHTR) is another asset held by Liberty. Liberty purchased an equity stake in Charter during 2013 and owned a one quarter interest in Charter as of the end of 2013.

Charter had been pursuing Time Warner Cable last year, and at various times was rumored to be partnering with Comcast to split up the Time Warner assets both before and after Comcast decided to go after Time Warner on its own. When Time Warner agreed to be acquired by Comcast in a merger, it valued the Time Warner shares at $158.82. Since then the value - tied to 2.875 times the Comcast share price - has declined. Following the release of Comcast earnings yesterday, and with Comcast closing at $50.83, the recent value would be $146.14.

In its initial press release, Comcast disclosed that it would divest "systems serving approximately 3 million managed subscribers" in order to reduce its post-merger market share to 30%. This market share level would correspond to levels that had been accepted by the government in previously approved mergers.

While this was occurring, Liberty extended a merger offer to Sirius early in January, and then withdrew the offer in March and announced it would instead be establishing two tracking stocks. One of the tracking stocks would include the Liberty one quarter ownership stake in Charter, its Time Warner shares and TruePosition, Inc. The other tracker would include Sirius, Live Nation (NYSE:LYV), the Atlanta Braves and most other assets and liabilities of Liberty.

Here's where it could get interesting. As of year end, Charter had $14.2 billion of debt, no cash and is already leveraged quite high under various measures. Charter is subject to debt covenant restrictions that take effect when the ratio exceeds 3.5x to 6.0x at various units. The net is that it has limited additional borrowing capacity. So, how will Charter raise that $20 billion?

It is not precisely clear, although it can certainly be presumed that Malone and Liberty Media will be involved. First, when Liberty took its initial stake in Charter, the 8k and press release noted the following ownership limits:

Subject to certain exceptions, [Liberty] has agreed that it will not, directly or indirectly, acquire voting securities of Charter in excess of 35% prior to January 2016 and in excess of 39.99% thereafter (the " Ownership Limitation "). In addition, [Liberty] is also, subject to certain exceptions, subject to certain customary standstill provisions that prohibit the [Liberty] from, among other things, engaging in any solicitation of proxies or consents relating to the election of directors, proposing a matter for submission to a vote of shareholders of Charter or calling a meeting of the shareholders of Charter or taking any action or making any public statement not approved by the Board to seek to control or influence the management, the Board or the policies of Charter.

The standstill limitations described above will cease to apply to [Liberty] beginning in January 2016 if Charter elects to terminate its obligation to nominate the [Liberty]'s designees for election at 2016 annual meeting of stockholders, as described above. In addition, the standstill limitations will cease to apply once the [Liberty] owns less than 5% of Charter Common Stock and upon termination by either party in 2017 and thereafter as described above.

When Liberty took that position in Charter, it used, in part, a margin loan that was backed by its equity in Sirius. Since then, Liberty has decided to liquidate 90% of its holdings in Barnes & Noble (NYSE:BKS) (raising just over a quarter billion dollars), sell one half billion dollars of its Sirius shares back to Sirius and issued a cash convertible note. That's hardly enough to provide significant help financing a $20 billion dollar asset purchase by Charter, and the funds still need to somehow get over to Charter. Or do they?

In a game of chess, there are complex strategies and many different pieces on the board with varying strengths and weaknesses. In the convoluted merger arrangement that already could include as many as five "pieces" - Time Warner, Comcast, Charter, Liberty and Sirius - the strategy is already rather complex. Buy there is another alternative strategy to a direct asset sale to Charter that involves a sixth piece and is apparently being considered. The Financial Times story noted that besides a straight sale there was:

...a scenario where Comcast and TWC spin off subscriptions into a new company and sell Charter a substantial minority stake. A combination of the two is also under consideration.

The "new company" would represent the sixth piece. Regardless of the arrangement, it seems that a significant amount of the capital to fund Charter's portion would come from Liberty. This could come from Liberty buying newly issued shares of Charter (increasing its stake up to the interim 35% ownership limit), lending funds to Charter or even by Liberty directly investing in the new company alternative. However, any scenario would require that Liberty raise a fairly substantial amount of cash - cash that seems likely to come directly or indirectly from Sirius.

Liberty could sell additional shares of Sirius, or may once again use its equity positions in Sirius (and Charter) as collateral for another margin loan, or revive its merger offer as soon as the trackers are set up. The issue with selling more of its Sirius shares is that it would threaten Liberty's majority ownership position unless Sirius was buying back both Liberty and non-Liberty shares at the same time. And if Sirius has to buy from both Liberty and non-Liberty owners, the amount that goes to Liberty would be cut in half. In addition, Sirius also has limits on how much it could immediately borrow for those buybacks.

A revived merger offer using the new tracker that includes Sirius could have a greater appeal to Sirius investors than the prior offer because it would allow Liberty to offer a larger premium to the non-Liberty owners of Sirius (Liberty would not have to give those shareholders a portion of the Charter assets). From a Liberty perspective, a merger could also give it more flexibility in accessing the free cash flow and borrowing capacity at Sirius. In addition to the flexibility, an added benefit would be that Liberty would have access to all the cash. But, if that route is followed, it is not entirely clear how the tracker set-up affects that cash moving around to help Charter.

Sirius will report earnings tomorrow, and in addition to the typical questions about subscribers, revenue and other metrics, there are certain to be questions about share buybacks, the tracker and the merger that didn't happen. The call should be quite interesting. Even more interesting will be the Liberty earnings call scheduled for May 8th when Liberty CEO Greg Maffei will be facing similar questions, and many more on the status of the recently reported discussions by Charter, Time Warner and Comcast.

Investors may have to wait until the Liberty call to get better answers and find out whether Liberty considers its Sirius asset a valuable chess piece or a mere pawn to be used to acquire cable assets for John Malone.

Disclosure: I am long CMCSA, 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: In addition to my long positions in SIRI, I have January 2015 $4 covered calls written against several of these positions. I also actively trade SIRI. I may initiate new covered call positions or close out or open new positions in SIRI at any time. I have no plans to trade any of the other stocks discussed in this article within the next 72 hours