What 2011 Holds for Sirius XM

 |  About: Sirius XM Holdings Inc. (SIRI)
by: King of All Trades

By Relmor Demitrius

One doesn’t need to go far to read an opinion on Sirius XM Radio (NASDAQ:SIRI) these days. From Forbes to the Wall Street Journal, online “hit” demand for this company is staggering. I’ve seen many articles get tagged for Sirius XM that actually didn’t even mention the company nor have anything to do with it at all. Is there a reason for this? According to the end of year filing from 2009, we had 950,000 investors in this security. That’s almost 1 million individual holders who have interest in this stock. As with anything, the more interest, the more information, the more people who provide the information, the more who comment on it, and the more misinformation that gets passed around. So you can imagine there are a lot of “experts” writing on this stock. Well sorry experts, but the amount of misinformation you are creating is staggering. Let's try to clear some of this up. My focus on this article is to explain important dates to Sirius XM in 2011, and the convertible notes that Sirius XM issued in July of 2008, due in 2014.

The first date that is approaching is the March 2011 time frame. In March of 2009, under the lending agreement and preferred share distribution agreement with Liberty Media (LINTA), Liberty has agreed not to add more than 49.9% of the common stock, until March of 2011. As of right now Liberty still only has the 40% preferred stake in Sirius XM, as well as $358 million in bonds. According to the agreement, in March of 2011, they allow Liberty the right to purchase the entire company, if they desire, by making a tender off for all shares. This doesn’t mean all or any holders have to agree and sell at this price, but if they do make a tender offer, or look to add over 49.9%, it would have to come in the form of a tender offer for all shares. This of course would still require board approval. This seems to somewhat coincide with the August 2011 date that marks the 3 year anniversary of the merger, and lifts certain tax restrictions regarding change of ownership, but more on that later as well. As you will see as these dates and situations are talked about, that they are all seemingly interrelated.

The offer would have to be board approved of course, and be no lower than the current market trading price of Sirius XM that day. This would not enact the poison pill (discussed below), as Liberty Media is exempt from its conditions, which restrict purchases up to 4.9% of the common stock. Currently no one has added shares to an amount higher than this, and no enaction of the poison pill has come forth.

So basically from today to March of 2011, Liberty Media cannot own more than 49.9% of the company, unless the board waives this. As they put it in, of course they won’t. Liberty wouldn’t erase their own value willingly. From March of 2011, to March of 2012, Liberty cannot add over 49.9% of the company, unless they make a tender off for the entire company. This would as I said earlier have conditions applied to it, please re read above for these.

After March of 2012, Liberty Media can add any amount and this would be also long after the poison pill expired and any NOL reductions from another change of ownership. So they would simply be a stockholder that can add any amount, already owning a 40% stake. They would obviously have the inside track on all buy out offers. Which bring us to the poison pill.

In April of 2009, Sirius XM created a poison pill that would dilute the stock if a hostile takeover attempt occurred. Due to the date of its expiration, August 1st of 2011, which is the exact date of expiration of the 3 year merger restriction on the change of ownership and how the NOL’s (generated by the company during its 10 years of unprofitability) could be accessed. This is a huge asset for the company and worth protecting. One can see why they used the poison pill to this date in time to protect these from someone attempting to buy the company before the 3 years expired. As the merger was the first change of ownership, another change of ownership, over the 49.9% mark, would constitute another loss in tax value, something Liberty wants to avoid. So after August 1st, 2011, the poison pill expires. Liberty is exempt from this poison pill, but it has worked to date, as no one has added close to the allowed 4.9%. It affects all stockholders on record prior to late May of 2009.

This clearly means that Liberty has intentions of adding or possibly gaining control, or simply doesn’t want anyone trying to buy them before that date and dilute their investment (meaning the 8 billion in NOL’s would disappear or be reduced dramatically, inversely affecting the value of their preferred shares). I suppose as these dates come closer, the March 2011 and the August 1st, 2011 dates, we will get a clearer picture of Liberty’s intentions. This could also spark some other buyout offers, or even a tender offer, as change of ownership has been reset after August 1st, 2011 and full NOL value is restored. After August 1st basically, the price of Sirius XM shares would be inherently more valuable. Liberty wouldn’t be the only buyer who could add significant amounts anymore, as they lose their poison pill advantage, and another buyer can make a move now that the 3 year freeze on the NOLs has lifted as well.

This leads us to the next important date, already discussed, and that is the August 1st, 2011 date when the NOL’s are reset. The taxable loss is worth billions to whomever owns Sirius XM’s profits in the future, and this aspect of the company should not be overlooked, especially with rising revenues, reduced costs, and higher margins. Profits are in their future, so ownership of the stock and use of these tax free profits for years to come are a nice advantage to any future owner and even of course the current owners. Obviously after this date the company goes up in value again.

On June 30th of 2011, the extended reverse split option the board could use ends. As stated this r/s would only be used to prevent a delisting, I do not expect them to extend this again, as the stock is now trading well over $1.50 a share. Institutional ownership is increasing, and I have no reason to believe current owners would even want a reverse split. I know Liberty Media doesn’t want the threat active, as it could massively dilute their ownership levels. As they are the largest holder, I would expect them to get their way here. I expect this to end with no fanfare. The reverse split seems to be off the table. Its only use would be to limit Liberty Media’s control. And that is only if they ever converted and tried to sell into the open market, or converted and tried to sell directly to another holder. Upon that time Sirius XM could issue stock that would take that 40% down a great deal, after the new authorized share counts came into play. To what advantage to current owners and insiders? None I can see, but it is something to think about. Upon the expiration of the r/s option, I believe the shares increase in value. This brings me now to the last topic, and the source of by far the most confusion lately.

To facilitate the merger in 2008, Sirius XM entered into what was described by Mel Karmazin, CEO of Sirius XM Radio, as “ugly financing”. This ugly financing was a 2014 due 7% convertible note, that converted at $1.87. At the time, Sirius XM was trading much higher at the time. To make matters worse, Sirius XM did what was unlikeable to current stockholders, they gave UBS and Morgan Stanley Banks approximately 260 million shares in which to short. These have since been known as the “lent shares” and were to be returned when the bonds were paid. Apparently at the time of the bond offering, Sirius XM shares were hard to borrow, meaning bondholders couldn’t obtain the proper hedge against this risky investment. They basically gave Morgan Stanley and UBS these shares for free (actually like .0001 cent each) and they sold 183 million of them for $1.50 a share. The current stock price at the time was well over this as well. Another 78 million shares were called “delayed offerings” and could be sold at any time, with no set price. In my opinion, these shares have yet to be sold. Of the 183 million shares, 60 million of them were returned already and destroyed, as per the agreement, in 2009. The facts are clear.

1. 261 million shares were lent out, OWNED by UBS and Morgan Stanley.

2. They sold 183 million of these in 2008 for $1.50 a share.

3. They could use this transaction to offer “put” option contracts as derivative hedges against sold bonds to bondholders. No shares where issued to bondholders. Startling? How do I know this? Cause they tell us that right here in the prospectus filing on the lent share agreement between Sirius XM Radio and UBS/Morgan Stanley, form 424B5 Prospectus Filed Pursuant to Rule 424, filed Jul 30, 2008 ...

“We have been informed by the underwriters that no borrowed shares will be sold by the share borrowers or the underwriters to Note investors.”

Why? Because bondholders probably only used puts to hedge, not shorted shares. It says in the same filing …

“It is currently expected that the short position established by the share borrowers in making the initial offering of borrowed shares will be used to facilitate swap transactions with investors in the Notes, which will be used by these investors to establish their initial hedge position in respect of their Notes.”

Basically this is what the underwriters did. They “sold” free shares they must return. This is basically entering a “short position.” They then used the money to purchase puts, and gave them or just insured the bonds themselves to their buyers. They then repurchased the shares at probably under .40 cents, booking a huge gain on the short side. This money is all profits, since the bonds are good, and probably resold much higher. I believe they dropped to under 50 cents on the dollar during the bankruptcy scare and are now trading over par. Nice gains. Some shares were returned when the stock bottomed, the 60 million, but all the 183 million shares sold at $1.50 have been repurchased as of this date, in my opinion. Looking at the chart, this is a no brainer.

Since they haven’t been all returned, they are still holding these repurchased shares. There are advantages to holding these shares. You can vote them, they are insurance in case of a bankruptcy, and they are also poison pill shares, as these shares were issued in 2008. Hence they are more valuable than shares purchased after May of 2009, which would not be covered under the poison pill. They could also be using them to occasionally make some money shorting the stock. As it is too bullish a company right now to fully short, I would expect these to be simple trades, and not bets against their fundamentals. This last is very speculative, and might not be happening. They could simply be sitting on the shares. They could even sell them again higher, and attempt another low re-buy, and then return them, but this is risky if the price gets over $1.87. Because if the bondholders convert at any price over $1.87, the lent shares must be returned immediately. If they needed to be purchased, they would have to buy them on the open market for current value. However, bondholders would never risk converting near their cost basis of zero, which would be $1.87 a share. I would expect the price to need to be at least $2.20 to $2.50 range before we saw any conversion and return of the lent shares. Keep in mind, these bond holders will make around 120 million dollars at the end of 2014 if they hold to maturity and take the cash, from now. So the price would have to reach at least $2.28 to break this expected profit. Convertible bondholders might be bullish the stock, but not enough to take chances. These are very smart holders and will probably look to maximize the benefit of owning convertibles. Meaning book the interest for as long as possible, and then one day converting to the equity for the long haul, or to make a much higher percentage wise than simply holding the bond to maturity. What bondholder is going to sit on a $4 price, when they can get shares for $1.87? Just to keep a 7% interest coupon? Not many I am guessing.

One last big event of 2011 could be a price increase in August of 2011 on the basic subscriber monthly charge. The FCC mandated a 3 year freeze on raising prices, so this would now allow Sirius XM to raise the basic subscription price for the first time in its history. Since stiff competition had prevented this in the past, and the FCC mandated it from 2008 to August of 2011, there really hasn’t been a chance till now. Even a $1 increase is a huge jump to ARPU, and to their bottom line. If up to $2 a subscriber, it could mean another 450 million a year in revenue. This would be almost 100% right to profits.

As you can see a lot is going on with this stock, the potential structure, and their fundamentals in 2011.

Disclosure: Long SIRI