When SiriusXM (SIRI) reports fourth quarter and full year results in less than two weeks I expect to see (as guided) that it generated more than $400 million in free cash flow (FCF) for the year. Assuming no other significant changes to the balance sheet, Sirius will have more than $800 million in cash. I also expect that Sirius will reiterate 2012 FCF guidance of $700 million, which would give it more than $1.5 billion by the end of the year. What will the company do with this pile of cash?
A year ago Sirius CEO Mel Karmazin stated that the company would rapidly be building cash and noted possible uses.
"So the obvious question that arises from this is what will we do with the cash that we accumulate over time. There are only three things a company can deal with a significant amount of excess cash, pay down debt, buy assets to grow the business or return capital to the shareholders. Our board of directors will consider all the alternatives and make the big decision that is in the best interest of our shareholders."
Karmazin went on further to say that he was comfortable with leverage at 3x and that the company saw no attractive acquisitions. So, if the cash would not be used to reduce debt and there are no attractive acquisitions, that left returning capital to shareholders. When questioned, Karmazin said:
"We have already had a discussion at the board level about what we should do with our free cash flow. No determination has been made. Historically, I've always believed that a share buyback is a more tax efficient way of returning capital to shareholders as compared to a dividend. But clearly, that's not anything that has been determined."
Since that time there have been many questions about the share buyback. Would Liberty Media (LMCA) participate? Not if you listened to comments by Liberty CEO Greg Maffei, who said that selling Liberty's shares of Sirius is not a logical option for Liberty. And if Liberty does not participate, then the Liberty percentage ownership would increase with a share buyback by Sirius.
But that's not the only thing working against a share buyback. A CNBC article titled Most Share Buybacks Don't Pay Off for Investors pointed to a recent Thompson Reuters report. As one can tell from the title, shareholders often don't benefit from share buybacks. A common perception is that companies will buy back stock because management believes share prices are undervalued. The statistics tell a different story. More often that not, the shares are purchased when the prices are high rather than low. Also interesting was that more companies saw poor returns rather than good returns after a buyback.
This is consistent with a prior study that found similar results. So why do companies persist with buybacks when results are likely to be less than stellar? The article has one very telling comment about the poor timing of buybacks:
"This may be partially explained by the need for officers of public companies to make some use of the cash on hand, including keeping less of it due to the possibility of being taken over."
As Sirius builds up cash, it makes it easier for Liberty to buy a majority using Sirius's own cash. Can Sirius avoid this by using the cash for other purposes? Not really. Liberty has wide ranging powers to veto many discretionary uses of cash, including paying a dividend. Will another company make an offer for Sirius to access that attractive FCF? It doesn't seem likely because of the 40% stake already owned by Liberty. There is, however, one use of cash that may appeal to both Sirius and Liberty.
There is a $550 million 7% Exchangeable Senior Subordinated Note due in August of 2014. Each $,1000 note is exchangeable for 533.3333 shares of common stock placing the price of the underlying shares at $1.875. Buying back these bonds would eliminate future share dilution, although the purchase of the bonds will require paying a substantial premium for several reasons, including the high coupon rate and the fact that the underlying shares are currently trading at levels significantly above the conversion price.
The shares underlying the bonds have caused some confusion in the past. If the price of the stock is over $1.875 at the end of the quarter, the price triggers a complex calculation that increases the diluted share count. This has occurred only once since the bonds were issued in August of 2008 -- at the end of the second quarter of 2011. Regardless, it would eliminate a potential 293 million share dilution.
As the release of earnings approaches and the cash continues to build, analysts are likely to be asking a lot of questions about the use of that cash. A share buyback, and even a dividend, seem to be unlikely uses of the cash. It could make for a very interesting Q&A session on the conference call.
Additional disclosure: I am long SIRI. I also have covered calls against some of my Sirius position. I may open new covered calls or initiate (or close) a buy stock/sell option position in SIRI, discussed in a prior article, at any time. I have no positions or plans to trade any other stock mentioned in this article in the next 72 hours.