Sirius XM: If Liberty Media Makes A Move, Who Gets The Premium?

| About: Sirius XM (SIRI)

Summary

Liberty Media controls 62% of SiriusXM stock.

Liberty Media recently created satellite radio tracking stocks.

Satellite radio trackers pave the way for getting satellite radio under one roof.

Sirius XM (NASDAQ:SIRI) investors have a lot more to pay attention to these days. For Sirius XM investors, it is just as important to watch what is happening with Liberty Sirius XM (NASDAQ:LSXMA). The reason it is important to pay attention to Liberty Sirius XM is that the delta between those tracking stocks and the underlying Sirius XM stock is what may determine which group of investors gets a modest premium in a deal that brings all satellite radio stocks under one roof.

First things first. It is my opinion that Sirius XM has a ceiling of sorts placed on it because of the fact that Liberty Media owns at least 62% of the company stock. This fact alone means that many items that could deliver value are off of the proverbial table. By example, a merger and acquisition activity would have to pass through Liberty Media. What if AT&T (NYSE:T) were interested in acquiring or merging with Sirius XM because it felt that the business was attractive? The fact that Liberty controls Sirius XM means that AT&T would have to go through Liberty. If the interest was high enough, AT&T might do that, but the process could be long and drawn out.

In my opinion, removal of the trading ceiling on Sirius XM, can get unlocked if the company was under one roof and the stock structure was one class of stock consisting of voting shares. Getting the company under one roof could be very simple or very complex.

The first thing that Sirius XM investors need to grasp is that Liberty Media is in the driver's seat. SIRI stockholders other than Liberty Media are in the minority. Depending on the type of deal that transpired, a majority of the minority would need to approve. The majority of the minority could be in the hands of just 40 institutional players, essentially leaving the retail investor out of the voting equation.

I penned an article entitled, "Liberty Sirius XM: Will Over $1 Billion In Value Unlock?" That article outlines things from a Liberty shareholders' perspective, but the thought process of that article is critical for Sirius XM shareholders to understand.

The first thing to think about is why Liberty Media created Liberty Sirius XM. One reason is to unlock value. Liberty Media (NASDAQ:LMCA) was trading at a discount to Sirius XM by as much as 20% at times. In concept, spinning off a tracker allows the satellite radio stake to trade free of other encumbrances. The tracker has indeed unlocked some value, but there is still over $1 billion in value that is trapped in LSXMA shares. The second reason Liberty would have created a tracker is to prepare for the eventuality that all Sirius XM shares would be under one roof. By having a pure Sirius XM tracker, a stock deal would be free of clutter from Live Nation (NYSE:LYV) stakes, The Atlanta Braves (NASDAQ:BATRA) stake, Barnes & Noble (NYSE:BKS), etc.

So, what we have is the groundwork for something in the form of satellite radio consolidation to happen. The type of offer that will eventually come will likely depend on what the delta is between the Sirius XM valuation and the valuation that the market is assigning to the Liberty media stake in Sirius XM. Are you confused yet? In simple terms, LSXMA and LSXMK stock are trading on "assigned value" vs. the true underlying stock of Sirius XM.

It is not uncommon for a tracker to trade at a small discount. This can be explained in simple terms because a tracker basically represents an I.O.U. of SIRI stock rather than actual SIRI stock.

In my opinion, if the tracker is trading at a discount of 5% or less, the sensible transaction from a Liberty media perspective is to buy out Sirius XM. The reason is simple. The small premium that Liberty would give Sirius XM stockholders is better than what might be expected if the discount were 5% or more. Let me explain in simple terms.

If Sirius XM has a $20 billion market cap, Liberty would control enough shares to represent $12.4 billion, and other shareholders would control $7.6 billion. If the Liberty $12.4 billion actual valuation is trading at a 5% discount, then the market cap of the Liberty tracker would be $11.8 billion. A gap of $600 million exists. It makes sense from a Liberty perspective to give about $200 million in premium to unlock $600 million in value. There is even room to offer a higher premium, but in no case will the premium offered be higher than the valuation gap that is trying to be filled.

Now, here is where things get interesting and where some Sirius XM shareholders will have a stroke. If the valuation gap of the Liberty tracker is above 5%, the potential path Liberty would take would be a hard spin, merging the Liberty stake into Sirius XM with Sirius XM most likely being the surviving entity. In this situation, Liberty Media would ask for concessions. Those concessions would likely be maintaining board seats representative of the 65% stake, keeping the current chairman in place, and even asking to have the Liberty stake increased post hard spin.

I will use the same assumed $20 billion market cap for Sirius XM. The Liberty "real value would be $12.6 billion, but if trading at a 10% discount, the market cap would be $11.34 billion. The unrealized value now is $1.26 billion.

The Liberty Media concession is that it is doing a hard spin that makes Sirius XM a standalone company that is not in the conglomerate of Liberty Media. Liberty would be placing its stake into a common place and essentially putting Sirius XM under one roof by itself. In this situation, Liberty is trying to unlock $1.26 billion in value. Let's use the same 2.5%. Liberty would capture this by requesting to hold 64.5% of the company after the spin. This would increase the Liberty stake from 62% to 63.5%. That 2.5% points represents additional shares that have value of $13 billion, or a premium of about $400 million.

It is imperative that Sirius XM investors understand these dynamics from a Liberty Media perspective because Liberty Media is holding the most cards, and it is Liberty that will drive such a deal, not Sirius XM. For Liberty Sirius XM shareholders, it is all about unlocking value, but not spending every bit of that unlocked value.

I often hear from Sirius XM investors that are very confused about this whole process and feel that Sirius XM shareholders should get a premium no matter what. These investors oft think that the 2014 deal was pulled because Sirus XM investors applied pressure. Nothing is further from the truth. Liberty made the offer because at that time the gap "discount" between Sirius XM stock and Liberty Media stock was almost 0%. In essence, Liberty's Sirius XM stake was almost trading at a premium to the underlying equity, so the Liberty currency was worth more than the Sirius XM currency.

I happen to hold both Sirius XM and Liberty stock. I do not really care which way the premium goes because it is my opinion that value will unlock either way. My strategy actually removes the worry about the premium from the equation, and actually allows me to assess this from a more realistic perspective than most. What I see very clearly is that the modest premium in either direction is not the thing to get hung up on or worry about. What is critical is getting the company under one roof. I happen to believe that Liberty holders will get the best play because they will either see more value unlocked than any premium paid, or will get more of a stake as a premium. As I have stated before, an arbitrage play exists here that can also be compelling.

The bottom line is that it is in the best interest of Sirius XM shareholders to monitor the Liberty Sirius XM trackers and monitor the relative discount. This will leave you well prepared to grasp any move that Liberty makes when it happens, and perhaps allow many investors to avoid confusion. For the small cadre of Sirius XM investors that feel a premium is deserved no matter what, all I can say is to hope that the trackers are at a discount of 5% or less, but never expect a premium that wipes out the potential unlocked value.

It is my hope that this article offers clarity to many. I will offer regular updates on delta between the trackers and Sirius XM, so be sure to Stay Tuned!

Disclosure: I am/we are long SIRI, LMCA, LSXMA, LSXMK.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in T.