Sirius XM: Making Sense Of What Just Happened

Oct.20.11 | About: Sirius XM (SIRI)

If you invest in the market long enough you will sometimes arrive at an “ah ha moment.” There aren’t many things that feel as good as finding such nuggets. Well, actually there are a few, but we’re not going to discuss them here.

They say hindsight is 20/20, and I agree. In the market, “hindsight” pales in comparison to the skill it requires to be “forward-looking.” After all, nobody makes money by investigating in forensic evidence, but rather by anticipating where the market is going. But sometimes many lessons can be learned and likely prevent future risk by investigating the carnage left behind.

On Wednesday, Sirius (NASDAQ:SIRI) released a Form 8-K where the following details were revealed:

  • In October 2011, an aggregate of approximately 202,400,000 shares of our common stock were returned to us from Morgan Stanley Capital Services Inc. and UBS AG, which we retired upon receipt. After giving effect to the retirement of these shares, as of September 30, 2011, we would have had 3,749,546,009 shares of common stock issued and outstanding. This figure excludes shares of our common stock issuable upon the conversion of the preferred stock held by an affiliate of Liberty Media and other convertible securities and upon the exercise of warrants and stock options that are currently outstanding.
  • In August 2008, we loaned 262,400,000 shares of our common stock to Morgan Stanley and UBS to facilitate the offering of our 7% Exchangeable Senior Subordinated Notes due 2014. In July 2009, Morgan Stanley returned to us 60,000,000 shares of our common stock that were borrowed. These shares were also retired upon receipt. We did not pay Morgan Stanley or UBS any consideration in connection with the return of the shares. Once borrowed shares are returned, they may not be reborrowed under the share lending agreements.
  • The shares loaned to Morgan Stanley and UBS were issued and outstanding for corporate law purposes. Under GAAP, the borrowed shares were not considered outstanding for the purpose of computing and reporting net income (loss) per common share. The retirement of these shares will have no effect on the calculation of our earnings per share.

The ah ha Moment

On Wednesday prior to the release of the 8-K, I wrote an article where some of Sirius XM’s recent trading activity had been highlighted. In the piece, I pointed out some of what I described as anomalies in both Sirius’ share price and volume. As I noted in my previous articles, money continues to be made on the stock with each trading day, both on the long and short side by its wild swings. But in light of the recent 8-K, let’s take a more comprehensive look at what recently unfolded.

As we noted, Sirius’ share price took a nosedive on October 4 to $1.27 before it quickly rebounded. But I have now come to realize why. In regard to the 202 million-plus shares noted in the 8-K, it went on to read: “After giving effect to the retirement of these shares, as of September 30, 2011.”

So if you are keeping score at home, you will understand that it cannot be a coincidence of any kind that the day prior (Sept 29), Sirius saw volume of almost 200 million shares, more than 50% above its normal day’s activity. Also on October 4, the day that the stock plummeted to $1.27 volume reached 180 million shares. By the volume indicated in the chart below, it becomes more than plausible to suggest that the return of these shares started between September 14 and the 22nd and completed on the 30th.

Click to enlarge

SIRItradingRange.PNGClick to enlarge

The stock has rebounded nicely since then but it continues to be a reminder that even though Sirius’ fundamentals continue to improve, the stock has not always traded on such concerns.

The History Of The Convertibles to enlarge

The convertibles were originally sold at the onset of the merger dating back to July of 2008. It is amazing how this now seems so long ago. Looking back, there were presumably many assumptions made by interested parties at the time. Most notably, from the CEO himself, Mel Karmazin, who remains highly criticized for mistakes made during the pre- and post-merger period.

In looking back and realizing some of the mistakes that were made, I have reason to suspect that management was of the assumption that the merger would constitute a change of ownership that would enact certain rights of the bondholders. Acting on this assumption, the company then sold the convertibles (due 2014) as a means to not only repay the existing debt, but also in an effort to avoid litigation that would have potentially prevented the merger (or at the very least, presented a roadblock). Well, we all now know how that turned out as roadblocks of other kinds surfaced.

Originally, as of the condition of the deal, the holders requested and were granted the capability to instantly short their positions against a “special facility” endorsed by the company that was administered by UBS and Morgan Stanley. Both firms established short positions on behalf of the converts using shares provided by Sirius XM. This is something that never quite sat well with me. In essence, this agreement effectively hurt the current owners.

What many do not realize is that both UBS and Morgan Stanley were charged with buying back an equal number of shares. Considering that they were allowed to hedge against it (short it), forcing them to buy an equal number of shares was to help stabilize the stock so it did not drop too dramatically.

Now, the key to understanding the converts is realizing the many options that they were afforded. Remember, we were told by Sirius management that these debts were “toxic." So the obvious question is, why did the converts assume the risk? I’ve come to realize that it was not much risk at all. Whether Sirius XM failed as a company or became a successful entity, the bond holders were put in a position where they absolutely could NOT lose.

Disclosure: I am long SIRI.