Speculation about SiriusXM's (SIRI) use of cash will continue, and likely increase, as the company's cash balance approaches $1.5 billion later this year. Investors and analysts are trying to determine what Sirius will do with its cash, what Liberty Media (LMCA) will do with its 40% stake in Sirius and what will be the impact on the share price of Sirius. (Liberty acquired its 40% stake in Sirius for a nominal fee as part of a complex loan arrangement that helped Sirius stave off bankruptcy and takeover attempts by Charles Ergen and EchoStar Corporation more than three years ago.) Last year during the year end conference call, Sirius CEO Mel Karmazin stated:
Growing EBITDA, no satellite CapEx, reduced interest payments and no meaningful income taxes will contribute to our dramatic free cash flow growth.
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.
...So will we buy assets with our excess cash? Perhaps, but we haven't seen anything yet that's worthy of any meaningful investment or acquisition. Then will we return capital to shareholders, although I certainly can't quantify the amount or the timing for this, I think it is reasonable to expect that the company will return capital to shareholders over time. Obviously, this perspective can change ...
And in response to a question, added:
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. We certainly have not heard anything specific from Liberty about their interest in having less ownership in the company. So certainly, from where I'm sitting today, we are not thinking about using the free cash flow to buy in Liberty shares as much as we might be thinking about using it for our public float.
As recently as March 8th when Karmazin was interviewed by Jim Cramer on "Mad Money," the issue of the build-up of cash, share buybacks and Liberty's interest again came up. As Karmazin finished discussing the free cash flow (FCF) growth, Cramer asked:
If that's the case, you've got one of the smartest guys in the world [Liberty's John Malone], the 40% shareholder in Liberty, why shouldn't they now that it's gone away start buying and buy the rest of the company for $2.50 which is capping all of the return that you can give shareholders?
I doubt Cramer expected a clear answer, and none was forthcoming. Cramer later asked:
Why not initiate a gigantic buyback and make all those people who have stuck with you and that stock for so long, recognize that you believe like they do that the stock is way too cheap?
And Karmazin replied:
It's a board decision, I would hope that the board would share my feelings that way, but that has to be the agenda. That absolutely has to be the agenda.
It sounds like a simple solution, doesn't it? Use the excess cash to repurchase the public float. I believe that Mel honestly thinks it is the best and most tax efficient use of the cash for shareholders. I also believe the cash will not be used for that purpose any time soon.
Many companies repurchase their outstanding float despite studies that show most of these companies overpay for their own shares. Wouldn't it make sense for current management to protect their positions by getting rid of the excess cash on the balance sheet and making Sirius less attractive as a takeover candidate? The answer is simple, and Karmazin gave it to us. It's a board decision. That board includes Liberty Media's Chairman John Malone and its CEO Greg Maffei. They, and the rest of the Liberty-appointed directors, have more power than a 40% stake would normally carry.
According to the loan agreement between Liberty and Sirius, along with the related documents:
For so long as an aggregate of at least 6,250,000 shares of B-1 Preferred Stock and B-2 Preferred Stock are issued and outstanding, neither the Issuer [Sirius] nor any of its subsidiaries will take any of the following actions without obtaining the prior written consent or affirmative vote of the holders of a majority of the outstanding shares of B-1 Preferred Stock and B-2 Preferred Stock, voting together as a separate class:
...any consolidation or merger with or into any other entity, the consolidation or merger of any other entity with or into the Issuer...
...subject to certain exceptions, any acquisition or disposition of assets, in each case, having a value of more than $10,000,000, or any series of related acquisitions or dispositions having a value in the aggregate of more than $20,000,000;
...conducting or engaging in any business in any material respect other than the business in which the Issuer and its subsidiaries are engaged as of the date hereof and any business reasonably related or complementary thereto;
There's more, but the point is that Sirius can't do many of the things the company's common shareholders might like without the approval of Liberty, at least not if my interpretation of the referenced document is correct. Without Liberty's consent:
There can be no bidding war for Sirius if Liberty wants to buy the company - note the selection about mergers.
There can be no significant acquisition or purchase of assets - note the $10/$20 million price cap
There can be no share buyback if that is considered an asset purchase (admittedly, my interpretation)
Will Liberty permit a share buyback? I just don't see it happening at the current time because I can't find the value in it for Liberty. There are a few comments that lead me to this conclusion. On numerous occasions Greg Maffei has stated that he thought the stock of Sirius was expensive. These comments were made at a time when the prices were far lower than they are today. He has also stated that he thinks that Sirius will grow into that valuation.
I also believe that Liberty wants to acquire the entire company. Liberty sees the same potential in Sirius that Sirius common stock investors see - the only difference is that Liberty wants all of that potential for itself. The free cash flow. The NOLs. And Malone & Maffei want to realize that potential in a tax advantaged transaction.
Originally, I thought there would be a two phase takeover, using cash to get to a majority stake followed by a share exchange using Liberty shares. Based on some additional recent comments by Maffei, it seems that the use of Liberty shares is unlikely. During the recent Liberty conference call, Maffei was asked by Barton Crockett of Lazard Capital Management about the method for monetizing the company's stake in Sirius using a Liberty share exchange to take control. Maffei replied that it was unlikely because the belief is that Liberty shares are trading at a discount. He also stated that if a takeover was the route the company were to take, it was more likely that Liberty would use cash to take control.
Summary and More Speculation
Speculation about a Sirius takeover by Liberty will continue as long as Liberty maintains a 40% equity stake in Sirius and as long as Liberty's shares continue to trade at a discount to its underlying assets. Also, the possibility of a share buyback - dependent entirely on what Liberty decides to permit - is unlikely to quietly fade into the background. Everything is up to Liberty.
And as long as this article started with "speculation," here is my speculation about events that could occur. Sirius will continue to build up cash and debt will be refinanced at lower rates, further building up cash. Eventually, when Liberty decides the price of Sirius is attractive, Liberty will use its cash and credit to buy a majority position in Sirius. When that is completed, Liberty will use the cash and credit of Sirius to fund the completion of the takeover.
There is a saying in the stock market. Sell in May, and go away. It is not unusual for market weakness to occur during the summer. This summer should be no different. Rising gas prices, polarization in Washington, tension in the Middle East over the threat of a nuclear Iran... These factors could all contribute to a weak stock market and present a buying opportunity for Liberty.
Disclosure: I am long SIRI.
Additional disclosure: I am long SIRI. I have $3 January 2013 covered calls against most of my Sirius position, as well as some $2 and $2.50 January 2013 covered calls. I may initiate (or close) a buy stock/sell option position in Sirius, discussed in another article, at any time. I have no positions or plans to trade Liberty in the next 72 hours.