If you are invested in Sirius XM Satellite Radio (SIRI), you are likely aware Liberty Media (LMCA) holds preferred shares that equate to about 40% of the company (if converted). Ever since Liberty's John Malone acquired those preferred shares and the stipulations that come along with them there has been a lot of conjecture about just what would happen. There are theories that Malone could just sit tight, theories that he will tender an offer for the company and take it private, theories that he will spin off his holding and conduct a Reverse Morris Trust, and theories that he could convert his shares, thereby flooding the market, and then buy up cheap shares. It is almost enough to make your head spin.
In the end, perhaps we can look at the Sirius XM and Liberty issue using a quotes from Donald Rumsfeld:
"I would not say that the future is necessarily less predictable than the past. I think the past was not predictable when it started."
"(Osama Bin Laden is) either alive and well or alive and not too well or not alive."
"Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns. There are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns - the ones we don't know we don't know."
"There's another way to phrase that and that is that the absence of evidence is not the evidence of absence. It is basically saying the same thing in a different way. Simply because you do not have evidence that something does exist does not mean that you have evidence that it doesn't exist."
You see, regarding Liberty and Sirius XM, there are a few things cast in stone, a few things that are good educated guesses, and then some things which we simply cannot know. Here are some things we know:
- Liberty has preferred shares that can be converted at any time into about 2.6 billion shares of common.
- Liberty has the right to appoint members to the board of directors in a balance similar to their stake in the company.
- Liberty can at any time between now and March 2012 put forth a tender offer for all shares of Sirius XM.
- Liberty (until March of 2012) is limited to an ownership stake of 49.9% unless they do a tender offer for all shares.
- In March of 2012 Liberty has no restrictions on ownership percentages.
- Liberty currently holds several hundred million dollars in Sirius XM debt.
- Liberty's John Malone has been known to be savvy when it comes to deals, and tends to find tax friendly ways to conduct his business.
- Liberty and Sirius XM have been in talks regarding the Liberty position.
- Sirius XM has about $8 billion in NOLs that are on the table, and depending on what Liberty does, they may be able to be utilized by Liberty, perhaps in a more efficient manner than Sirius XM can.
- Sirius XM CEO Mel Karmazin's deal runs through the end of 2012, and he has expressed that he does not like being second in command.
- If Sirius XM buys back shares without buying back preferred, the Liberty stake on a percentage basis will increase.
- Liberty needs a controlling interest (over 50%) in order to begin a Reverse Morris Trust.
- Liberty needs an 80% stake to utilize the NOLs.
- In the case of a Reverse Morris Trust, Liberty has six months to reach the 80% threshold after going above 50%.
So now, knowing what we know, we can begin to look at the various paths that can happen. Part of investment research is assigning probability to things. Sometimes this is not an easy task, but if we take the time to understand the known issues, we can begin to assign reasonable assumptions to future actions. Some reasonable assumptions are:
- Liberty holds the best cards.
- Malone will act in the best interest of himself and/or shareholders in his company. That best interest may not align with the shareholders of Sirius XM.
- At some point Malone will want to utilize his stake in Sirius XM to make yet another move. This could mean trying to cash out, or it could mean buying more.
- Malone's vision of his stake in Sirius XM may not align with Karmazin's.
- Liberty has the most freedom in March of 2012.
So what we have here is a bunch of facts and reasonable assumptions. It is from here that we can begin to assess what actions Liberty might take. None of this is cast in stone, but given our knowns and assumptions, we can begin to see a picture taking shape. So what possibilities exist?
Liberty Does Nothing
The answer could be as simple as Liberty does nothing. They could simply sit on their preferred stake in which their cost basis is nothing. If Liberty does nothing, they will simply report their stake in Sirius XM on their financial's and march along as they have since they first obtained the preferred shares. The problem with this scenario is that Liberty is not getting cash out of the investment. They have shares worth billions, but have no real (or meaningful) access to the value. Certainly if Sirius XM is performing well the gains there could offset another aspect of Liberty not doing so well, but the reality is that sitting still is only really a temporary strategy. At some point, realistically speaking, Liberty needs to make a move.
Liberty Does A Tender Offer Before March of 2011
This is a possibility, but likely a remote one. Right now Liberty can not go above 49.9% ownership in Sirius XM unless they tender an offer for the entire company. In addition, the board would have to approve this offer. That is a hurdle the company will not need to navigate in March. In addition, Liberty does not need all of the shares to enact the plan. However, any realistic plan requires that they at least go above 50%, something they cannot do without a tender offer at this point in time. If Liberty makes a tender offer simply to try to gain control, they could be throwing money at something that they do not really need to buy, and doing so at a premium. Liberty, most likely, would not want to show their cards until they are ready to make their move in its entirety. Depending on the ultimate strategy, phasing into greater ownership may carry more risk than doing it in one swoop. Owning Sirius XM outright is not the typical way Malone does business. Thus the likelihood of outright ownership is small.
Liberty Waits Until March And Takes A 50% Stake
In March Liberty has no restrictions and can do whatever it wants. In March they can move up to a 59% stake in the company. Merely getting to 50% affords them no real value. They already carry a huge interest in the company and have a sort of "veto power" on how the company operates in terms of cash use and any new debt. Simply getting to 50% does not gain them a lot if that is the end game. What is more likely is that they would go to 50% for another reason, which is starting a Reverse Morris Trust.
A Reverse Morris Trust is used when a parent company (Liberty with a greater than 50% stake) has a subsidiary (Sirius XM) that it wants to sell off in a tax friendly manner. The first step is that the parent company (Liberty) completes a spin-off of the sub-company (Sirius XM) to the parent company's (Liberty) shareholders. The sub-company (the Sirius XM Stake - is now owned by the parent company's shareholders) then merges with a target company to create a merged company. This transaction would be essentially tax free as long as the sub-company (the Sirius XM Stake) is considered the buyer in the merger.
This type of move would allow Liberty to essentially "cash out" of the investment in Sirius XM is a virtually tax free manner. The downside to this is that Liberty would not really have access to use the NOLs (Net Operating Losses) which are a reported $8 billion and carry a cash value of over $3 billion. In order to have access to the NOLs, Liberty would need to go up to an 80% stake.
This strategy gains support if Sirius XM's stock price moves substantially higher, thereby making it more expensive to go to 80% and narrowing the delta of benefit from the NOLs.
In this situation Liberty would simply need to get the stake to above 50%, spin off the stake, conduct a Reverse Morris Trust, and merge the spinco into Sirius XM, a company run by current Sirius XM management.
Liberty Waits Until March And Takes An 80% Stake
This move would be a longer term play. The reason for taking an 80% stake is that Liberty would now be able to utilize the NOLs. This could be a prudent move, effectively allowing Liberty to benefit from the NOLs, but is a longer term strategy, as it would take time to use them all up. This would likely delay the ability to cash out the stake, but they would be gaining a part $3 billion in the cash value of NOLs by simply investing enough to acquire another 2.6 billion shares. At current market prices such a transaction would mean an additional investment of about $4.7 billion.
In theory Liberty would invest an additional 4.7 billion but get access to tax incentives of NOLs worth an estimated $3 billion. Wile dramatically over-simplified, Liberty could control 80% of Sirius XM for an effective cost of much less that the $4.7 billion it would cost to get to 80%.
The driver of this move would be a Sirius XM equity price that remains deflated when the time comes to cut the deal (March). If the cost to buy enough equity is low enough, the carrot of the NOLs becomes that much more tempting. Liberty could also get help along the way if Sirius XM conducts a share buyback and Liberty does not participate. In effect the Liberty stake would increase because the company is buying back common.
Liberty would still then be free to conduct a Reverse Morris Trust. It would simply become a tax shield for billions.
Liberty Waits Until March And Buys The Whole Company
This is a possibility as well. Why haggle at the 80% level if you can simply take over the company in its entirety, and do it in a tax friendly stock transaction? The benefits would be similar to what was outlined above, but with Liberty having total control instead of an 80% stake.
If this were to happen, Liberty could still use the NOLs, exhaust their value, and still conduct a Reverse Morris Trust later if they so desire.
At issue here is that this type of takeover is not typical of Malone.
Liberty Sells Preferred Shares To Someone Else
Another possibility is that Liberty moves the stake in Sirius XM to another party altogether. They could conduct such business in a tax friendly stock transaction, and in effect divest themselves of their interest in Sirius XM in trade for another entity that they want to be invested in. This is an option that many have not really talked about.
In the end you can see that there is a lot we know, and a lot we don't know. But one thing we do know is that something will happen. At this point paying attention to what Liberty is doing is perhaps more prudent than ever before. What investors also need to consider are these easy points with regard to Sirius XM:
- A substantial increase in the stock price of Sirius XM makes the 50% move more likely than the 80% move.
- A subdued Sirius XM stock price increases the odds of the 80% move.
Disclosure: I am long SIRI.