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Over the past three years SiriusXM (SIRI) has made a lot of investors a lot of money. Those that took a chance and invested in the company when it was on the brink of bankruptcy, or shortly after, have been handsomely rewarded. Liberty Media (LMCA), which also took a chance by lending Sirius the funds necessary to get the company through its liquidity crisis, was the biggest winner. Not only did Liberty earn 15% on the loan it made to Sirius, but as part of the loan agreement it was also able to buy a 40% stake in the company for the nominal fee of $12,500. The loan was paid off and the shares underlying the 40% equity stake are currently worth $6 billion.

A month ago, all standstill restrictions that limited Liberty's ability to take control of Sirius expired and speculation about what Liberty intends to do have continued. Will Liberty go to 51% and take hard control of the company? Will it spin off its stake to Liberty shareholders? Will it sell the stake to a third party? Will it participate in a potential Sirius share buyback or block a share buyback? Will it sit back and do nothing?

The Sirius Share Price - How high is up?

The issue that should be of the most interest to Sirius investors is how much is Sirius stock worth? Most investors in Sirius, or any company, view their shares as fairly valued or undervalued, and expect to see the share price go up. But how high is up?

There have been a wide range of prices projected for Sirius. Yahoo!Finance shows 13 brokers with price targets ranging from $2 to $3.20, with an average of about $2.50. Yahoo also reports two thirds of the analysts that cover the company rate the stock as outperform or buy with only one rating the stock as underperform, very similar ratings to a Reuters summary. So, where is the value in Sirius?

It's clearly not in the current or next two years' earnings per share (EPS) estimates. Yahoo reports these as seven cents for 2012 and eleven cents for 2013. Is it the growth beyond that time frame? Is it the Free Cash Flow (FCF)? Is it the possibility of a takeover by Liberty? Is it in the value of the company's nearly $8 billion of NOLs? Is it something else?

Under the broad category of something else that will drive the share price higher, there are several recurrent themes. These themes include:

  1. Sirius could grow dramatically by easily replicating the US model outside of North America
  2. The company will show explosive growth when the auto market and/or the economy recovers
  3. A party other than Liberty Media will swoop in and force a bidding war
  4. There is untapped value in the spectrum that the FCC licensed to Sirius and XM

I see little realistic opportunity in any of these, but would like to examine item 4. more closely.

Assessing the Value of the FCC Licenses

XM and Sirius were each granted FCC licenses to use 12.5 MHz portions of spectrum in the 2310-2360 Band allocated for "BROADCASTING-SATELLITE." How much is the spectrum worth? Liberty's CEO, Greg Maffei, made these comments around the time of the loan to Sirius:

As a senior lender, do we think that one of the assets that's attractive is the spectrum they have? Absolutely.

and,

The great dream, perhaps, is that you have ... 150 audio channels on one consolidated Sirius XM platform that only consumed [half] of the spectrum, and [the other half] becomes therefore available for mobile video. That would be a great intersection of where the skills of Sirius XM and DirecTV reside.

There is an inherent assumption that the licenses will be renewed in any valuation methodology, and there are any number of ways that the licenses can be valued. The Balance Sheet in the 10k shows more than $3 billion in intangible assets and goodwill, which includes, among other assets, a portion of the "fair value" of the FCC licenses. But that's a number that is used mainly for accounting purposes to periodically assess whether or not the asset has been impaired.

Another point of reference is the proposed agreement between Verizon Communications (VZ), Comcast (CMCSA), Time Warner Cable (TWC) and others to transfer licenses representing 20 Mhz of spectrum. The arrangement, currently being reviewed in the Senate, has Verizon making total payments of $3.6 billion. Cross-marketing of Verizon Wireless products are also involved.

However, without its licenses, or an agreement that allows Sirius to use the spectrum, Sirius can not broadcast to their subscribers. If unable to broadcast, the company would be unable to fulfill its obligations to subscribers or its OEM partners. And, if the company is unable to fulfill its obligations to subscribers, Sirius will be unable to generate revenue as a satellite radio provider.

The great dream...

If SiriusXM migrates to a single broadcast platform, as Maffei speculated, the theory is that half the spectrum will be freed up for other uses. It's a nice thought, but as a practical matter, it's far off in the future. OEM partners plan on supporting the vehicles that are sold today well into the future. When a customer buys a car with an AM/FM radio, it is expected that the radio will last as long as the car. The same is true for the satellite radio, and there's the problem.

The satellite radio isn't of much use as a satellite radio unless there are satellite broadcast signals for it to receive. XM radios receive signals through the XM licensed spectrum and Sirius radios receive signals through the Sirius licensed spectrum. Even if the next generation satellites is capable of broadcasting both XM and Sirius signals, that doesn't change the fact that the radio in the car is designed to receive signals from only half the spectrum.

Investors should also keep in mind that Sirius has announced several agreements over the past year to re-activate radios in used cars. These are for both Sirius and XM radios and presume the company will maintain broadcasting through the full spectrum. Sirius CEO Mel Karmazin also spoke about turning on a limited number of ad-supported stations as a way to monetize many of the inactive satellite radios at some point in the future. Has anyone stopped to consider that these are both Sirius and XM radios and require broadcasting over the company's currently available spectrum?

Limited Spectrum

Sirius has a limited amount of spectrum available to support its subscribers. Using 90 Khz per channel only gives Sirius a maximum of 145 channels for their Sirius platform and 145 for their XM platform. That's all the spectrum the company has. Maybe less bandwidth can be used for talk radio and one can skimp a bit on music channels, but at some point there is no more room to expand the channel line-up without degrading the crystal clear music quality that many subscribers are willing to pay for.

Can the company broadcast video from the satellites to a receiver? Technologically, yes. And if it's a small enough screen, the video quality might be okay, but the company would need to eliminate some of the audio stations. How would the FCC react?

FCC Licenses

The Sirius FCC licenses have restrictions. From the 10K:

Failure to comply with FCC requirements could damage our business.

We hold FCC licenses and authorizations to operate commercial satellite radio services in the United States, including authorizations for satellites and terrestrial repeaters, and related authorizations. The FCC generally grants licenses and authorizations for a fixed term. Although we expect our licenses and authorizations to be renewed in the ordinary course upon their expiration, there can be no assurance that this will be the case. ...

The operation of our satellite radio systems is subject to significant regulation by the FCC under authority granted through the Communications Act and related federal law. ... Non-compliance by us with these requirements or other conditions or with other applicable FCC rules and regulations could result in fines, additional license conditions, license revocation or other detrimental FCC actions. ...

The terms of our licenses, the order of the FCC approving the Merger, and the consent decrees we entered into with the FCC require us to meet certain conditions. Non-compliance with these conditions could result in fines, additional license conditions, license revocation or other detrimental FCC actions.

Any entity acquiring Sirius or its licenses with the intention of using the licenses for purposes other than those originally cited in the applications, need FCC approval and could face a significant risk that the FCC will not permit the changes.

Summary

Sirius is in the business of providing curated content to its subscribers. Although some of its subscribers are currently receiving content through IP, the overwhelming majority are receiving signals from satellites broadcasting in the SDARS spectrum that Sirius and XM acquired during the last century. To remain in business, Sirius either needs all its spectrum or to cut down on the number of stations it chooses to offer. And, cutting out stations is almost certain to cost Sirius some subscribers.

If at some point in the future, Sirius is able to convince all the OEMs to move to a single platform, a migration could begin. This would allow the company to eventually free up half its licensed spectrum, but that date is probably at least a decade after the OEMs are all migrated to a single platform. At that point, perhaps, Greg Maffei's "big dream" would be realized. For now it is more of a pipe-dream.

Several years ago MasterCard ran an ad campaign with a common theme. One TV commercial featured a young man walking around New York City handing out Yankee tickets to strangers wearing or holding items with Yankee insignias. The closing shot was a view of a section at Yankee Stadium with all the strangers that had received the tickets and the tag line "Tickets in the new batter's eye view section, only with a MasterCard. Inviting some new friends to the game - priceless." When it comes to Sirius staying in business, the value of the spectrum - priceless.

Source: Sirius XM: Placing A Value On Spectrum

Additional disclosure: 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. Except as stated, I have no positions or plans to trade any of the other stocks mentioned in the next 72 hours.