There’s a saying that I have often believed to be true that suggests, “Where there’s smoke, there’s fire.” If you have been following the coverage of Sirius XM (SIRI) over the past couple of weeks, you probably need to get your lungs checked (just to be on the safe side), because you have likely inhaled a lot of smoke – I know I have. The question is, where’s the fire?
Buy the Rumor
In a recent article, I talked about the continuous acquisition rumors that surround Sirius XM and Liberty Media (LCAPA). Speculation surrounding such a topic reached national media on Monday when Wedge Partners’ Senior Analyst, Martin Pykkonen appeared on CNBC to discuss the topic – hence, fanning the flame. But is it more than that?
Last week, when speculation resurfaced, I said this:
*Sometimes (as investors) the lines blur between what we want (which is often instant gratification) and what is sensible. The fact that a Sirius acquisition has not yet happened is very telling and should be factored into any possible future decisions. Am I suggesting that it will never happen? No, only that Liberty’s criteria for acquiring Sirius at this juncture have not been met.
*Sirius' current and/or recent share price is all but a small factor in what Liberty is considering in terms of value in a whole ownership. The NOLs are no longer a factor and should no longer be considered a valid argument. We seem to continue to overlook the fact that Liberty currently and will continue to benefit from SXM's 8 billion dollar NOL due to its 40% ownership regardless of what happens from this point forward. The fact is, Liberty is rewarded by virtue of its equity ownership.
*Liberty has all of the benefits of ownership without all of the risks. The company will continue to allow Sirius to improve its fundamentals and operate as a separate entity and still reap the rewards of its performance. But investors should not view this as a negative. Sirius continues to prove each quarter that it is more than capable of being a viable company and will continue to seek ways to increase shareholder value with or without an acquisition. At current prices, a Liberty acquisition is the last thing investors should hope for since an "undercut premium" would likely be the net result.
I’m highlighting these three bullets in order to get a better understanding of what is likely to happen and also because it leads into breaking down comments made by Martin Pykkonen on his CNBC appearance. I think we have seen a lot of “buying the rumor” going on with the stock and I think it is important for investors to know if it is substantiated. The fact that the stock is going up is the great thing, being smart with its current direction can be the difference between your portfolio’s status should a “sell the news” occur.
“All-in bet on Sirius”
This was the title of the New York Post article that promoted Martin’s CNBC appearance. I took a bit of exception to that article because it started by saying “John Malone is finally getting serious about Sirius.” - Really? Was a $530 million loan and a 40% stake in a company not convincing enough that he was already serious about Sirius?
The article offered no new revelations regarding the two companies, but only discussed items that have been previously speculated upon for now three years – hence, fanning the flame.
What follows next is a Q&A between Martin and CNBC.
Do you think John Malone stands ready to increase his stake in Sirius?
Yeah, I do actually. There was a Liberty analyst meeting. There wasn't anything new as far as information, but I felt for a while that john individually, I think the team at Liberty believes in Sirius management, and the outlook for their company. It is a perfect fit for their kind of a story.
How undervalued is Sirius?
Sirius right now is valued really on a traditional operating margin or EBITDA margin range and if you look at it in the low range, it is in the low teens which is medium for an entertainment company but if you look at it on a cash flow basis which is the way it should be viewed, it's a high single range.
Over the next year or two, continued growth in subscribers, a price increase which will flow through very smoothly at the beginning of the year, very modest price increase. the price increase, it won't have like a Netflix (NFLX) thing?
Do you think customers would accept it (price increase)?
I would put my money on this being a very successful price increase in comparison to the case you just mentioned (Netflix).
Quick comment then, should investors buy Sirius? Is that what you're recommending?
We don't officially rate nor have price targets on stocks but I do like the Sirius model over the long term. Right now liberty owns 40% of it. I’m not sure that they will go necessarily to an 80% which is controlling stakes but they will likely go above 50%, and probably within the first quarter of next year when the NOLs come through from Sirius to liberty. (End of interview)
I think Martin was pretty consistent with some of my views which is a full purchase of Sirius by Liberty is probably not in the best interest of either party. This does leave the door open to what we have always known to be the most likely scenario which is that Liberty is likely to increase its stake at some point – more likely now in the first quarter of 2012. The question investors now want to know is, how should it be played? The answer is simple – be long.
Disclosure: I am long SIRI.