Sirius XM, Liberty Media And Pie

Aug.13.14 | About: Sirius XM (SIRI)


Pie is good.

More pie is better.

As Liberty Media's share of Sirius XM's pie grows, it can offer more, for less.

Do you like pie?

If you answered "yes," you are correct.

If you answered "no," then you are lying, and the rest of us are watching you closely, and guarding our pies.

Some time ago, I wrote an article that compared Liberty Media (NASDAQ:LMCA) to a hamburger. It's one of my most viewed articles to date, and one of the articles which I received a considerable amount of criticism for. Food provided the perfect reference for discussing Sirius XM's (NASDAQ:SIRI) relationship with soon to be majority owner Liberty Media at the time, and the basic idea has held up to date.

It's that time. Again.

So how about a little dessert?

Investors in both Sirius XM and Liberty Media are well aware of an offer made earlier in 2014. The offer was made by Liberty to minority holders of Sirius XM, and proposed an equity swap, which would allow Liberty to go to full control and for Sirius XM holders to receive equity in the "new" stock.

The deal offered was complex in many ways, and certainly misunderstood by many. Thankfully, it was retracted, but it is widely expected that in the future another similar offer will be presented. What Sirius XM investors should focus on is the premium that was offered to the going share price at the time and what may be expected in the future.

As I usually do, I'm going to use numbers for example purposes, as the overall concept here is all that is important.

First, consider the first pie here as illustrated in delicious black and white.

At a 50 / 50 ratio between the two, for every share of Sirius XM that retail and institutions own, Liberty media owns a single share as well. What happens here if Liberty Media offers a premium valuation to the other side in an equity swap? For a 5% premium Liberty might offer, it would cost Liberty 5%. At this point, unless there's a disconnect between the value of Liberty Media itself and Sirius XM, in Liberty's favor, then it makes little sense for Liberty to offer much of a premium at all. Considering that Liberty was not much over 50%, that also introduced complications to Liberty offering a larger premium. Liberty just didn't have it available to offer without resulting in some costs to its own shareholders.

There was a lot of complaining that Liberty's offered deal earlier in the year did not offer enough of a premium to other holders of Sirius XM. That may not be the case on the next offer.

By the time the next offer comes through, Liberty will have completed a separation of various parts of its company so that the resulting umbrella its holdings in Sirius XM fall under will be more of a "pure play" in Sirius XM. Basically, the resulting Liberty Media will be made up of a much greater percentage, by market cap, of Sirius XM's value.

Likewise, assuming that Sirius XM continues and completes its currently authorized $6B in buybacks, the "pie" might look like the next delicious black and white picture below.

Again I have simplified this for example purposes but if trends continue it would not be unreasonable to expect that Liberty Media will eventually own 75% of Sirius XM with the remainder being owned almost completely by institutions and a very small part being owned by retail holders. Liberty's stake has been increasing as it has not been selling back to Sirius XM's buyback, and institutions have been maintaining or adding to position. Retail? Selling out. Bored, scared, confused, or for whatever reason, retail has been selling almost all shares that Sirius XM has purchased and retired in recent history.

So what does all this mean? Liberty Media gets 75% of the pie in the example above without spending a penny to get there from the previous 50%. Also, relative to the remainder, now the ratio of Liberty owned shares is 3:1 instead of 1:1. This gives Liberty tremendous bargaining power in terms of offering a premium to the remaining institutions and small contingent of retail. Consider that a 15% offered premium here costs Liberty only 5%. Also consider that in the example Liberty got 25% of that pie for "free" simply by holding and not selling back.

Everyone has a price, and in an equity swap vs. a cash buyout, where investors are given a new company that is still vast majority comprised of the old company, it is very easy to take a respectable premium and agree to an offer.

I believe institutional investors are aware that this could potentially be the case and are willing to wait.

As with anything, not everything is so simple. There are additional numbers here and complications that can be introduced to skew actual benefits or detriments to either side. The core idea, though, holds up:

  • As Sirius XM buys back shares and Liberty does not participate, its share of ownership increases.
  • As Sirius XM buys back shares and Liberty does not participate, other's share of ownership decreases.
  • Premiums to the minority can be increased at less cost to the majority, the larger the majority grows relative to the minority.
  • Everyone has a price. Eventually, the premium will be enough and an equity swap would be agreed to.
  • I believe this is expected by institutional investors and is part of the reason institutions have held fast or added to positions.

So what does this mean for the retail investor? Just be aware. Be aware that as time wears on, another offer may come through and the premium offered may be enough, or may even be considerable when compared with the premium offered originally.

Holders of Sirius XM would do well to understand the dynamics of a potential equity swap as I see that as inevitable in the future. If you are invested now and expect that you will be able to refuse and hold up the process, forget it. This would be decided by the majority of the minority and the majority of the minority is already made up of institutional investors who likely would not be opposed to a "free" bonus in equity so long as it was of appropriate size.

In my opinion, it's a good thing, and at some point in the (near?) future, a much better offer will come through the pipes. It's a reason to hold. It's a reason to buy.

Disclosure: The author is long SIRI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long SIRI January 2015 $2.50, $3 and $3.50 calls. I am long SIRI Aug 16 $3.50 calls.