For Sirius XM 54% May Be The New 50%

It was not to long ago that Sirius XM (NASDAQ:SIRI) CEO Mel Karmazin took a stance that "40 was not the new 50" in regard to the Liberty Media (NASDAQ: LMCA) request for de facto control of the licenses currently held by Sirius XM. In defending the licenses, Sirius XM argued that Liberty did not have de facto control over the company and the the current board was in control.

Depending on how friendly or contentious the negotiations are between Sirius XM and Liberty Media, Liberty may need to take its stake not to just above 50%, but instead to the 54% level.

Technically speaking Liberty Media can do a lot once it gets above the 50% mark with their stake in Sirius XM. Liberty started with 40% back in 2009 when it bailed out Sirius XM in the midst of the banking crisis. In December of 2011, Liberty entered into a forward purchase agreement for notional shares, which if exercised (Liberty has indicated that it will indeed exercise this purchase and has already paid \$230 million toward it) would take the stake to 45.2%. The same day the forward purchase agreement was announced Liberty bought another 60 million shares on the open market taking its stake to 46.2%.

The reason that 54% is the new 50% is that the Sirius XM board is made up of 13 members. Up until this point Liberty has had 5 of those seats, indicative of its 40% stake in the company. The move to 46.2% ownership could theoretically entitle Liberty to a 6th seat at the boardroom table in July, when it does take possession of the shares tied to the forward purchase agreement. Think of it this way. Each board seat represents 7.69% of the company:

1 out of 13 = 7.69%
2 out of 13 - 15.38%
3 out of 13 = 23.07%
4 out of 13 = 30.77%
5 out of 13 = 38.46%
6 out of 13 = 46.15%
7 out of 13 = 53.85%

As you can see, the only way Liberty can gain actual control of the board is by moving its stake up to 54%. This could carry a substantial meaning as we move forward. If Sirius XM wants to play hardball, it will be quite uncertain what direction this matter will take even if Liberty has just over 50% of the company. If Liberty wants to make things easier, it will need to go to 54% and gain the 7th board seat. Such a move would put it in control of the board as well as a majority stake in the company.

For investors in Sirius XM and Liberty Media this presents an interesting set of circumstances. At the moment everyone is focused on the 50% level, indicating that liberty is only a small 3.8% stake away from control. However, if we consider the board seats, Liberty needs more than double that stake (an additional 7.8%).

I can already see the wheels turning in the minds of investors. I can picture people once again thinking that a substantial premium is on the way because Liberty will have to purchase another 400 million shares instead of 260 million. One consideration however though is that institutions with large blocks of shares are aware of this as well. In fact, the phone lines at Liberty could well be lit up with large shareholders wanting to cut a deal of their own.

Further, if negotiations get this intense and contentious, shareholders in both companies may suffer more than needed. Special meetings would need to be held, proxy votes, and delays that overhang the equities until the final resolution is complete. For what end? To delay what already seems inevitable? To buy time for a last ditch attempt at something that carries small odds for success?

As I have been contemplating these issues for quite some time, and rethinking each possible move, I arrive at some pretty simple conclusions:

1. Sirius XM does indeed need to have some answers for shareholders at the annual meeting. There are substantial events happening, a substantial amount of corporate cash that is not yet being used, and shareholders that are growing impatient with the lack of answers or direction. If Karmazin and company can get through the meeting to the satisfaction of the street, the pressure will be somewhat lifted.
2. Liberty will not likely make a move for board seats, etc. unless there is a breakdown in negotiations. Remember, Liberty does not hold the voting rights on the 302 million notional shares until July 6th when a settlement is scheduled to happen. That is too late for the annual meeting scheduled for May 22nd. I realize that Liberty could back out of this deal, but realistically speaking it simply is not going to happen. We have a better chance of seeing another man on the moon between now and then.
3. The NOLs (NET Operating Losses) of Sirius XM are a consideration, but the benefit they deliver pales in comparison to the benefit Liberty Media would get in conducting a Reverse Morris Trust. Where SIRI shareholders would lose is if these companies cannot come to terms to structure a workable deal and Liberty decides that the pain involved to preserve them is simply not worth it. Yes, Liberty would need an 80% stake to access them through negotiation, but a change of control (Liberty going over 50%) that is not structured properly and through negotiation could put them back on the shelf.

At this point the writing is on the wall. It is now simply a matter of whether or not the path to get there is easy or filled with land mines. The easy path delivers the most shareholder benefit in my opinion. Look for Liberty to build toward a stake over 50% no matter what, and a stake of 54% if things are not progressing smoothly enough for Liberty.

Disclosure: I am long SIRI.