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Summary

  • Sirius XM is currently in the middle of a large-scale share buyback.
  • I expect buybacks to continue beyond the 'to date' $4 billion authorization.
  • If done properly, returns can be expected long term despite short-term neutrality.

As all Sirius XM (NASDAQ:SIRI) investors should understand by now, the company is in the middle of a $4 billion share repurchase authorization. Considered a form of return of capital, a share repurchase takes cash or debt, repurchases shares, and retires them. The effect? Those who hold, now own a larger percentage of the company.

In simplistic terms, assume a company at $5 per share with 5 billion shares outstanding. If that company uses $5 billion in cash or issued debt to repurchase 1 billion shares, then the remaining holders own 25% more of the company.

It's at this point that some begin to disconnect from the more complex issues. Many assume that if one owns 25% more of the company that the shares should now be worth 25% more, or $6.25. What is missed here is that the company either reduced its cash, or added debt in order to retire the shares. In the short term the net effect is neutral and has no effect on valuation, and thus share price, beyond normal market gyrations. While a buyback can and often does buoy the share price while the buyback program is purchasing shares, it does not magically make the company worth more.

The key here is that this is a long-term issue. I've seen many comments that, when it comes to Sirius XM, the buyback has not been effective. It's a comment which completely misses the entire point. If one is looking for instant gratification, well, all buybacks will likely seem like a failure.

To understand why this is a long-term issue one needs only to understand how this all works. I'll explain.

The goal.

The goal of a share repurchase program is to, hopefully, buy back shares at a relative under valuation today based on where the share price might be in the future. If cash can be used to do this or low-cost debt, then the company only needs to outperform the cost of the buyback. In Sirius XM's case that means performance needs to exceed a debt cost of what is currently 6% and under.

The difference in company performance vs. costs of the buyback translates into gains, assuming the company outperforms the costs. If one assumes Sirius XM is able to grow at a rate of, say, 15%, then the gain on the repurchased shares should be roughly 9% per year.

The execution.

Sirius XM has been using debt issuances and free cash flow in order to repurchase shares under current authorizations. All repurchases to date have averaged in the mid $3s. This is higher than the current share price, thus current repurchasing activity has the effect of bringing the average purchase price down. This will be favorable in the long term.

What investors want to see is that the company executes its repurchase plan diligently. Those with a longer-term horizon will want the lowest possible average price on shares repurchased, just like an investor would want to purchase shares at a lower price for greater future gain.

Considering that Sirius XM is currently treading water at the bottom end of its historical EV/EBITDA valuation, investors should be pleased with repurchases in this area at the low $3s.

The result.

It's important to stress that results take time. As stated above, because a share repurchase is shorter-term neutral, it takes time for the compounding effects of the difference between the costs of the program and the benefits of company performance to work. While the undulations of the market do not allow this to behave exactly like the more familiar compound interest curve, the general idea, and shape, is the same.

The most important shares repurchased? Those at the beginning. Relatively speaking these shares should be the cheapest and offer the greatest long-term return. The lower priced the shares are, the more shares that can be retired.

Assume a cost of debt at 6%, company performance increase of 15%, and thus a 9% compound appreciation on the shares repurchased. Over a 5-year period this can turn a $4 billion "investment" into $6.15 billion, a 54% gain. If shares are purchased at a discount, or near the lower end of historical valuations, that gain down the road can be even more substantial.

If one assumes fair value of Sirius XM at $4 per share currently, the current share price represents a 27% discount to the mid range of its historical valuation. Purchases here, assuming the mid range of valuation is reached again in the future, already offer 27% upside before that 9% compounding comes into play. The effect? Instead of 54%, investors should expect near 100% appreciation on shares repurchased at this level over a 5-year period assuming the company posts 15% growth.

By adding the cumulative effects of the share repurchase over time, and assuming linear appreciation of the company, Sirius XM is positioned to offer exceptional shareholder value going forward. In order to realize those gains, though, investors need to understand that this will take time. The longer? The better.

Those with a short-term perspective or those who wish to judge efficacy of a multi-year and what may be a decade-long share repurchase program will likely find Sirius XM's repurchase program lacking. That's absolutely fine in the opinion of this longer-term investor. Short term, Sirius XM needs sellers to buy from so those shares can be retired. If you are unhappy with the current share price or do not have a longer term view, then Sirius XM will be happy to buy your shares from you.

Source: Sirius XM: Buyback Return Requires Long-Term Horizon

Additional disclosure: I am long SIRI Jan 2015 $2.50 and $3 calls as well as $3.50/$4 spreads.