In the previous article, we went over not only the history of the relationship between the two companies, but also several key conditions of what can supposedly culminate into a Sirius (NASDAQ:SIRI) acquisition by Liberty Capital (LCAPA) or some type of "spin-off." Now before we re-hash all of the possibilities between the two firms, let's take a moment to go over what we know.
What we know
What we know is that Liberty owns 40% of Sirius' preferred shares that was the result of a $530 million loan issued to Sirius two years ago that prevented Sirius from a bankruptcy filing. We also know that with the preferred shares comes the option to liquidate the shares in a conversion to common; something that would not bode well with existing shareholders as that would be highly dilutive. But we also know that they have insisted that this option will not be exercised. This came from a quote by Liberty CEO Greg Maffei when asked about the possibility of converting the 40% to common he said:
"I do not believe it is likely that we will trigger the gain in Sirius. There is virtually no scenario I can think of that my chairman would let me even talk about doing that."
This made Sirius investors feel a little more comfortable about not only their current holdings, but even about the possibility of acquiring more. We also know that Mr. Maffei, during the same discussion, issued the following statement:
So you're talking about something we're either likely to, somewhere down the road, find another way to get liquidity in Sirius or become a purchaser of Sirius. And I think we've talked about that in the past. So it's a logical alternative."
From that point forward investor imaginations ran wild. While nothing was guaranteed from that statement, the mere mention of Sirius as a potential acquisition from a Liberty insider was enough to spark both suspicion and anticipation. But to fully understand the context in which the statement was said requires a greater understanding of what Liberty is allowed to do, not only from an investor standpoint but also from a legal perspective.
We know that on April 12th Liberty filled more seats on Sirius' board, which prompted many to suspect that they might make a play for Sirius as early as this July. I've been asked many times for my opinion on this possibility. While this would not shock me if it were to happen, it would shock me for it to happen so soon. I keep reverting to the restrictions that we talked about in the first part of this article. Let's take a look.
We know there were hedging restrictions in place that prohibited Liberty from engaging in such activities prior to December 31, 2009. There was also the standstill restriction that states until the second anniversary of the close of the Phase II investment (on 03/06/11), neither Liberty Media nor affiliates may acquire beneficial ownership in SIRI that would result in more than 49.9% ownership without the approval of the SIRI board. It also states from the second to third anniversaries of the close, Liberty Media may not acquire any beneficial ownership greater than 49.9% unless it is pursuant to an offer for all outstanding shares not owned by Liberty Media at a premium to the previous day's closing price.
Finally there's the transfer restriction that states Liberty Media may not transfer any portion of Sirius holdings to any party other than an affiliate until the second anniversary of the close of Phase II of Liberty Media's investment which would have been March 6, 2011.
Implications of the known
Per the agreement with Liberty, they were not allowed to exceed 49.9% of Sirius ownership without prior written approval of the independent common directors (ICD) until March of this year. It is also worth noting that between March 2011 and March 2012, the agreement also prevents Liberty from surpassing 49.9% ownership without prior written approval of the IDC. This is where it gets tricky; they can't do so unless "the acquisition or offer or agreement to acquire such Common Stock is made pursuant to a Permitted Tender Offer."
I say this is where it gets tricky because that phrase may be defined and interpreted differently by various investors. Because a "permitted tender offer" is defined as an offer to purchase all of the remaining outstanding shares between March 2011 and March 2012.
Though speculation remains as to how much Liberty is able to acquire, the reality is they were and are limited to only an additional 9.9% ownership in Sirius. Something also that I found very fascinating was to learn of the true motivation of Sirius' enactment of the poison pill. Also, while some may speculate otherwise, the shareholder rights agreement was put in place to make Sirius less attractive as it would dilute the shares making it twice as expensive for an acquiring entity to exceed 4.9% of the outstanding shares.
We mentioned earlier that per the investment agreement Liberty could not exceed 49.9% ownership without the IDC approval. But in light of the recent board appointees by Liberty, I think it's worth mentioning that the new appointees along with the existing members, John Malone, Greg Maffei, Mel Karmazin and David Flowers, are all excluded from voting consideration should an approval be needed. After all, it's hard to be "independent" with such critical insiders involved. Investors have wondered for two years when a buyout was going to arrive, but in spite of what has been previously speculated upon to this point, an offer was not realistic until recently; as of March 2011. It says so right here on page 11 of article IV.
It is also worth noting here that both the agreement with Liberty as well as the shareholder rights agreement was purposely structured to prevent any new 5% owners from going beyond 49.9% ownership until August 1, 2011; this also includes Liberty. August 2011 is pretty significant here for a number of reasons in my opinion, because I believe this is when the fun starts. I think the true anticipation for a tender offer should include the window between August 2011 and March 2012.
Before we continue, let me remind you of some very important points previously made. Per the agreement with Liberty, they were not allowed to exceed 49.9% of Sirius ownership without prior written approval of the ICD until March of this year. Also, between March 2011 and March 2012, the agreement prevents Liberty from surpassing 49.9% ownership without prior written approval of the IDC unless "the acquisition or offer or agreement to acquire such Common Stock is made pursuant to a Permitted Tender Offer". A "permitted tender offer" is defined as an offer to purchase all of the remaining outstanding shares between March 2011 and March 2012.
I also told you that both the agreement with Liberty as well as the shareholder rights agreement was purposely structured to prevent any new 5% owners from going beyond 49.9% ownership until August 1, 2011, which then led to my prediction that the actual " tender window" was more plausible to expect between August 2011 and March 2012. Here's why.
August 2011 – March 2012
I think Liberty acquiring Sirius is unavoidable. It will happen, the only question remains when? This has been a hot topic of debate for quite some time. I have always maintained for over a year now that if anything were going to happen between the two companies, it would not occur until August 2011. Though I stand by that date, I'm now willing to expand the date of execution window to March 2012. The major reason for this is something that we have discussed very little, the NOLs or Net Operating Losses. The net operating loss for Sirius can be used to recover past tax payments or reduce future tax payments.
The value of the NOLs depends on who you ask. But in my opinion, the fact that nothing has happened yet implies (to some degree) that one or both parties consider the NOLs extremely valuable. Because if Liberty were to make a move not only would they have violated the investment agreement, but they would be costing themselves billions of dollars by putting added restrictions on the NOL's.
For those who are unfamiliar with the term (NOL), just remember because corporations are required to pay taxes when they earn money, they also deserve some form of tax relief when they lose money. We know prior to Sirius becoming profitable, they had mounted significant amounts of losses. As of December 2009, Sirius reportedly had NOL carry forwards of approximately $8 billion available for federal and state income tax purposes to offset future taxable income. If that is not value, I don ’ t know what is.
So in order for these tax shelters to remain intact, a tender offer cannot arrive sooner than August 2011. With that, I remain firm in my belief that the NOLs along with the language in the investment agreement are what inspire "this patience" we are witnessing. I suspect this virtue will continue until March 2012. It is also worth mentioning that August 2011 is when the Section 182 limitations on Sirius' NOL's expire.
In addition to a tender offer, we talked about Liberty possibly doing a "split-off" of Sirius. Again, I would not expect this to occur before August 2011. At that point, Liberty can make an offer for whatever percent of Sirius it feels it needs. Once they have sufficiently increased their stake, and then would enact the "split-off" which would then be owned by Liberty’s existing shareholders. The benefits to this include not only will there be no taxable implications to this, but it can potentially reduce Liberty’s outstanding share count.
The new "special purpose entity" or "split-off" that Liberty would have created could then be united with Sirius. This would allow shareholders of the split-off company as well as Sirius shareholders to conduct exchanges for new shares; whether majority or minority where required. These transactions would not only be tax free, but it would also allow Liberty the option to make necessary adjustments to bring more value to the float by way of share reduction.
As you can see from this series, there have been many discussions regarding the many possible scenarios between Liberty and Sirius XM. What remains true is that not only has Sirius been one of the best investments in Liberty’s portfolio, it has performed even more remarkably for investors who have stuck with the company for the past two years since its low of 5 cents. The future looks equally promising for both companies; whether as separate entities or if joined via a merger. But if I were to bet my money on the possible outcome, it would be the latter. Knowing that August is only three months away, it makes me wonder, will Liberty stand still?
Disclosure: I am long SIRI.