What Price Should SiriusXM Shares Be?

Mar. 7.12 | About: Sirius XM (SIRI)

Picture a TV commercial (it's the third one in YouTube video link) with four guys dressed in leather jackets with their hair slicked back (think Fonzie from Happy Days, or better yet, Bowser from Sha Na NA) singing an acapella doo-wop arrangement:

When you think you're ready,
Go down to Crazy Eddie,
The man whose got most everything in stereo sound
His audio selection,
Will meet with your perfection,

The chorus eventually concludes:

And so the story's told,
Across the whole wide world,
Crazy Eddie will not ever be undersold.

It was a new tagline. Those in the New York, New Jersey, Connecticut tri-state area may remember the Crazy Eddie TV ads. The discount electronics retailer's earlier TV ads featured a screaming lunatic telling viewers that he won't be undersold and ended with the tag line "His prices are INSAAAAANE!!!" Eddie was Eddie Antar, who later went to jail for defrauding investors out of tens of millions of dollars.

Crazy Eddie would certainly have carried the SiriusXM (NASDAQ:SIRI) products. And their high pressure salesmen would have tried to sell you extra peripherals in a discounted bundle -- picture a car salesman going to his manager to cut you a deal on an option package or extended warranty. But it is not audio entertainment sales or the doo-wop music available on SiriusXM, or the auto sales rep tie-in that reminded me of Crazy Eddie. It was the "prices are insane" tag line.

I thought about insane prices as I was reading articles and comments about where the price of Sirius shares should be. Much of the speculation about the share price has been inspired by the third anniversary of the Liberty Media (NASDAQ:LMCA) loan to SiriusXM. For those unfamiliar with the importance of the event, here's an abbreviated history.

What happened three years ago?
Following the collapse of Lehman Brothers in late 2008, the credit markets were in turmoil. There was little trust, and a loan was nearly impossible to get. In this environment Sirius had a bond coming due. Charles Ergen had bought up Sirius debt that was maturing, hoping to force a default and take control of the company.

Sirius turned to Liberty for a loan. The terms were incredibly steep-- to put it mildly. The interest rate was 15% AND Sirius gave Liberty preferred stock that could be converted to common stock representing 40% of the company. As bad a deal as this seemed, it was better than the one purportedly offered by Ergen. If Ergen had been successful in forcing a bankruptcy, shareholders would have ended up with nothing.

The provisions of the loan were extensive and included "Standstill Restrictions" that limited the ability to acquire SiriusXM for a period of three years. This week those restrictions lapse.

Speculation Runs Rampant
Leading up to the third anniversary, analysts and investors have speculated how Liberty would monetize its investment in a tax efficient manner, and how much Liberty should be willing to pay. Actions by Liberty have also provided fuel for this speculation. On November 17th Liberty issued a pair of press releases announcing a restructuring and a new $1.5 billion credit facility. According to Liberty CEO Greg Maffei:

The board of directors determined this was the right move to increase the value for both Liberty Capital and Liberty Starz shareholders by eliminating the 'tracker discount', increasing liquidity in the stock and creating a stronger acquisition currency. In addition, we recently took advantage of the attractive debt markets to raise capital at Starz, and we have more opportunities to deploy it at a combined Liberty Media.

Maffei has also discussed possible options for Liberty with regard to its Sirius stake, including increasing its ownership. He has also stated that selling their shares is not a logical option and that Liberty loves its stake in Sirius because of expanding operating margins, rising free cash flow, reduced capital expenditures going forward and the tax shield.

I like Sirius for many of the same reasons as Liberty, and I agree with those that think Liberty will acquire Sirius. What is unclear is the date of an acquisition attempt and, more importantly, the price Liberty will pay.

His prices are insaaane!
Insane prices. It's the way I feel about many of the share price points suggested as reasonable for Sirius. I see no justification for anything above $3 per share and find $2.50 to be an unrealistic stretch. It just isn't warranted based on the free cash flow (FCF) of Sirius. There will be those that argue that there is value in the Net Operating Losses ((NOLs)) that will shelter income from taxes. But the NOLs are ALREADY largely factored into the FCF, and are one of the reasons the FCF will be so high for the next several years.

There are those that argue the price doesn't reflect the value of the FCC licenses. In the sense that other businesses might be willing to pay for alternate uses of the spectrum, there is no guarantee that it would be allowed by the FCC. The spectrum was awarded to Sirius and XM for a specific use and the two companies were permitted to merge and become a monopoly based on certain additional restrictions. And for those with short memories, the FCC held up the merger of Sirius and XM for a very long time before giving its approval. The FCC would certainly conduct an extensive review if any acquirer wanted to alter the use of the spectrum and there are no guarantees that it would be permitted. In addition, without the spectrum, Sirius would no longer be a satellite radio company.

There are going to be others that proclaim the strong fundamentals of Sirius will drive the price of the shares higher. Reasons given include the subscription price increase, strong auto sales, the Hispanic market, 2.0, the used car market, speculations about international and other uses of the spectrum. Some of these could be potential positives, but are they fundamentals?

I have always thought of fundamentals as the components on the balance sheet, the income statement or the sources and uses statement, and in the case of Sirius, its metrics on subscribers (which drive revenues and costs). Some of these have been improving. Debt has been reduced, revenue, subscribers, cash and free cash flow are rising. Others are not quite as positive. Subscriber cancellations are increasing, churn and conversions are not improving. It costs the company an increasing amount to add each net additional subscriber as subscribers cancel in record numbers.

Liberty management has better information than any analyst
Investors should realize that Liberty management has a great deal of insight into the prospects of Sirius. Liberty has members on the Sirius board and it would have seen and questioned the business plans and guidance for 2012. That guidance shows a slowing rate of subscriber growth. A slowing growth rate typically results in a contracting P/E multiple and that's not conducive to a high share price.

And that's a reason for Liberty to be cautious and take its time.

Maffei, at a UBS conference, stated he thought the price of Sirius stock was high when it was trading at $1.83 on January 4th. It wouldn't seem that the current price of $2.20 is going to be attractive two months later.

Ask yourself some questions: How much-- after cash return-- do I want for each dollar that I invest? Then look at some projected future cash flows per share for each of the nearly 7 billion diluted shares. How much are you now willing to pay for Sirius? The answer might surprise you. (You can find some clues here). If you find out that you wouldn't pay $2.50 to $3 per share, why should Liberty? One last question: Do you think a $3 price is INSAAANE? I know I do.

Disclosure: I am long SIRI.

Additional disclosure: I am long SIRI. I also have $2 and $2.50 January 2013 covered calls against some of my Sirius positions. I may open $3 January 2013 covered calls and/or initiate (or close) a buy stock/sell option position in Sirius at any time. I have no position in Liberty.