Short Interest and the Sirius/XM Merger

In an article published Wednesday, 247Wallst.com writer Douglas McIntyre addresses the current short interest in Sirius Satellite Radio (SIRI) stock, but in my opinion has missed some major points that need due consideration.

It is McIntyre’s position that the shorts are betting against the merger, and further, betting that Sirius will crash and burn. In his piece McIntyre states, "those betting against Sirius believe that one of two things will happen. The first is that the merger with XM Satellite (XMSR) will not go through. That would almost certainly depress both stocks. The market is counting on the merger for cost savings.”

If McIntyre’s position that the merger will not pass holds true, then short activity would see a spike in BOTH equities. Additionally, when a merger is on the table, Arbs come into play. Arbs play the delta between the deal as announced and the current prices of the equities. The Arb play with this merger would involve shorting Sirius (the acquiring company) and going long XM (the company being acquired). By trading in this manner, the Arbs can lock in a profit position that represents the delta between the current trading ratio and the announced 4.6 shares of Sirius for each share of XM. The Arbs, by nature, would INCREASE short positions.

McIntyre calls the 114 million short shares staggering. This is also curious. What needs to be considered when looking at short interest is the ratio relative to the overall float, as well as the day to cover a short position. Additionally, the number of convertible shares needs to be considered. Holders of convertible shares will often play a spread similar to what Arbs do, virtually locking in a set return by shorting the equity against the convertible shares that control.

In Sirius’ case, the short interest spike began when analysts began to anticipate and publish reports that a merger decision was nearing. This would be indicative that a certain strategy was afoot. Yes, there are those that are shorting because they are betting against a merger, but the camp betting on merger approval is likely as large, and the Arb play is a safer investment strategy in terms of limiting losses should an investor have guessed wrong. Additionally, there have been periods when short interest in Sirius represented more shares than the current level. With Sirius’ trading volume, the “days to cover” the current short interest is 2.77 days.

To see the Arb strategy at play, one can also review the XM short interest and the days to cover. Investors can note that the “days to cover” for XM stands at 3.12 days, much less than the up to 5 days that have been in play over the last year or so.

This is not to say that McIntyre is entirely wrong with his article. There are indeed people betting against a merger, and against Sirius. However, with a merger in play, and having discussed the merger in his article, McIntyre should have considered the Arb strategy, which is a common strategy in situations such as this. For many, a short interest spike in Sirius was expected. It is a safe way to play the merger, and in particular if the merger is approved.

Position - Long Sirius, Long XM