By Relmor Demitrius
According to Mel Karmazin, CEO of Sirius XM Radio (SIRI), 2008 was “the merger year” for Sirius XM Radio and 2010 was the year of transitioning to profits and free cash flow growth. Then I say 2012 is the year of decisions. 2012 will hold vital decisions on the next few years and future of the companies structure and leadership. There are many important decisions coming from the Board of Directors and possibly Liberty Media (LINTA). Last week we got a glimpse into what that future might hold as Greg Maffei commented on such things at the UBS Global Media Conference on Monday Dec. 5th. This conference also had David Fear, CFO of Sirius XM, speak as well. Also Mel has been beating the drum on making a decision about his future as well, as his contract will expire in December of 2012. Postering is already beginning on that front as well.
In 2009 Mel Karmazin made comments about his future, as his contract was coming due at the end of the 2009. His current deal runs from 2010 to 2012. He stated then in 2009 he would not be second fiddle to anyone. He would rather do something else, suggesting a desire to start a fund himself. He stated maybe something new would be in order. This was of course postering and a warning to the board and the new 40% owners at the time, Liberty Media. He has now made the exact same comments in 2011. These comments came at a Reuters Media Conference from November. Basically with Mel Karmazin, its CEO and total control, or nothing with him. This is no new information to the board or Liberty.
Looking at the subscriber totals and improvements to the debt ratio and balance sheet since 2009, as the merger was his baby, I would have to say Mel was worth every penny and he has done an amazing job worthy of another 3 years. Was he perfect? No, but no one is of course. Has he made mistakes? Probably. Is he being sued for fraud by his own company? Yes he is, as is the entire board. This is from the handling of the Liberty Investment deal. This is an overhang on the board, but I don’t feel will be a factor in Mel and the board's decision. As of right now, Mel has probably 7 board members minimum who are loyal to him and are from the company long term. I think Frear, himself, Amble, Black, Gilberti, Hartenstein, and Barry are locks to vote for Mel. That's 7 of 13 board votes right there. There are another couple members that are independent additions that might favor a new direction, and then there are the 3 members from Liberty. Basically if Mel wants to come back, he should have the votes. If Liberty wants to go to a proxy situation and remove board members who would vote for Mel, then they have that right. I do not believe Liberty would go to such a drastic step to remove Mel. If they do not like the direction of the company, which they have stated time and time again that they do like the direction and are happy with their investment, then they might buy over 50% and just control it that way. If they feel management can no longer be trusted and the company must be more run “hands on”, which is not how they operate, then they might go that route. However since they are happy with the company, and are “riding the growth path of Sirius XM”, as stated at their Liberty Investment Conference slide show from this year, I expect no such course of action, at least for this purpose.
Mel has stated he wants clarity as to what Liberty’s intentions are with the future of the company. Are they going to allow a buyback? Or they going to allow preferred shares to be rebought? Are they going to take a controlling interest? If they do, what reassurances will Mel have that he will be in control? All these things are issues, in my opinion, to Mel re-signing with the company and why 2012 is a big year for decisions. I believe if Mel likes what he sees from the board and gets cooperation from Liberty on their future structure, stock options (buyback..etc..) and he gets the money and option packages he wants, then I am confidence Mel will be back for at least another couple of years. There is still much to transition with the company and the evolution and growth story of the company is nowhere near complete. If Mel set out to start and finish a job, he would be quitting at the half way point as I see it. I feel Mel sees this merged company now as his baby and he isn’t going to let it be raised by someone else without a fight. Management protection is a huge issue and Mel has a personal and financial interest in its success going forward. He owns 120 million stock options at around a 47 cent strike price and many more millions of actual shares himself. He re-signed with the company in July of 2009. Using this as a guideline, meaning I believe Mel will want to get a deal done before nearing the end of the year, I would expect heavy decision making and board meetings to occur in the first half of this year.
I think there are fights going on right now in the board room. I believe the Liberty is holding to a belief that a buyback of common shares will increase their percentage of ownership, as it is a static amount of shares due to them. They are protected from delusion in the investment agreement. I believe negotiations for how or if a buyback would work hinge on the wording on this agreement and could ultimately come down to Liberty having to sue to see their interpretation enforced or they concede the issue. Sirius XM management can enact a buyback and not have it affect what is due percentage wise to Liberty Media, without permission from Liberty. Now if Liberty doesn’t want this, they might try to gain a controlling interest or seek legal avenues. Basically not only did they steal 40% of the company for a free, now they want to hinder future stockholder value by handcuffing their options on how a buyback would work. I guarantee this is what Malone is trying to get. They might however allow a buyback, if Sirius XM buys back an equal amount of corresponding preferred shares as well, thus keeping the percentage at 40%. This would reduce the float, but hold Liberty’s percentage as equal. But in order to reduce the float, Sirius XM would have to basically “double spend” to do it. They would also have to buy back whatever amount of preferred would keep it at a 40% stake. This would allow Liberty to pull money out without hurting their own ownership levels, while it benefits stockholders by reducing the amount of shares in the float. This situation wouldn’t be ideal for stockholders, but it would be better than nothing. There are public comments from Mel and Malone and Maffei that seem to hint there are some hidden things going on that we don’t yet know about. When Mel calls Malone “the Doctor” and laughs about it, you know something is up. We will know soon enough.
Sirius XM is ok with a buyback just reducing total shares, and not affecting Liberty’s percentage. That is not what Liberty maybe trying to do here. They may want a way to reduce the float while increasing Liberty’s percentage at the same time, which would nullify any value in a buyback, and not have to sell back preferred shares as well. Sirius XM would rather buy back preferred first of course, but if that answer is no, then Mel would go the other route, buying back common shares. Since Mel Karmazin has been touting a buyback since 2009 as a viable option in returning shareholder value, I believe this was and is still the working condition that Mel is going forward with. If Liberty wants to prevent this then they have the only option of going to court, or becoming a majority owner. In my opinion, preventing a buyback from occurring without keeping Liberty’s percentage the same removes all value to the buyback and why Mel and the board might be in talks to work this out to benefit both parties. Both sides want the stock to appreciate and are on the same page on that. This is why I am hopeful an agreement can be reached and the company can move forward with the buyback plan, and re-sign their leader, Mel.
Another decision facing the company in 2012 is how to handle the upcoming debt situation. Mel can refinance out the 2013 13% bonds due to maybe 2018 with a new 6% interest rate. This would improve their interest payments immensely, while using no cash in the process. This allows cash to be used now on a buyback. They can also decide to take on new debt, roll out the bonds, and use money from that offering or cash on hand to begin a smaller scale buyback plan, being announced in 2012. Once this buyback plan is announced we will know what the situation is with how a buyback would affect Liberty’s percentage. I expect an announcement in the first half of the year, probably in Q1 or Q2 conference call at the latest.
Although March is a date that allows a full investment into Sirius XM from Liberty Media, Greg Maffei at the Dec. 5th UBS Conference warned that this date really has no significance to them. If they were interested in a majority stake, he said then why didn’t Liberty add in the open market to 49% when the stock was trading at 15 cents in 2009. It would be illogical to add now basically when a cheap stock was ignored for so long. It has always been my contention that a free 40% stake is much more valuable than putting in good money to get to 50% or 60%. This gives risk now to a once risk free investment. Remember, Liberty's cost average on their Sirius XM investment is zero. It's all 100% profit to them. Every dollar used to buy more exposes them to more risk. With practically control over big cash usage and happy with the day to day operations, this makes the least sense to me. Greg Maffei spelled out their options on Dec. 5th. He stated they basically have 2 choices.
1. Do nothing.
2. Add to take control. They could also do a spin-off of course and some type of merger down the road as well. Any merger would require a 50% controlling stake first. He stated Liberty does two things usually with an investment. They either get out of it quick with a tax benefit, or hold long term. This is a hold long term situation with them.
Selling their stake, or converting and selling is not an option. Book it. It isn’t happening. They are not going to lower their percentage of control anytime soon. Maybe down the road if the stock gets over $5. Then a small scale out to book profits might be reasonable at that point. Maybe then they would sell their stake back to the company. Once maximum saturation of the market is achieved, I wouldn’t blame any investor for wanting to put the future risk of the company in someone else’s hands, especially when that investment was risk free to begin with.
The only way I see Liberty wanting control is if a decision on future use of cash cannot be reached with management, and they want full board control. In this scenario, Mel Karmazin would not be retained as CEO. I wouldn’t be surprised if Greg Maffei became the new CEO at that point.
So as you can see the company has a lot of things to resolve in 2012. It is going to be interesting to see how they handle debt, if Mel comes back ,and how they handle a buyback. A buyback Mel said would be a 2012 board decision. Keep in mind that their debt to leverage ratio will be at 2 to 1 by the end of 2012. They stated they want one of 3 to 1. Could this mean they take on debt to do a buyback? It is in the cards. Or it could be a partial use of debt, with some cash on hand as well. Only time will tell.
Disclosure: Long SIRI