A Sirius Case Of Share Dilution?

| About: Sirius XM (SIRI)

Ever since Liberty Media (NASDAQ:LMCA) announced on May 8th that it had "Entered into a forward purchase contract for 302 million shares of SiriusXM (NASDAQ:SIRI), with a forward price of $2.15 per share for a total notional amount of $650 million," all sorts of speculation has been taking place. Can Liberty force me to sell my shares? What if I don't want to sell my shares? Why only 302 million? Who has that many shares? Where are all those shares coming from? Do they really intend to go through with it?

I have seen a number of comments that suggest that the shares to be acquired under the Forward Contract are probably coming from the 7% Exchangeable Notes. Briefly, as described in the Sirius 10K:

The Exchangeable Notes mature on December 1, 2014. The Exchangeable Notes are exchangeable at any time at the option of the holder into shares of our common stock at an initial exchange rate of 533.3333 shares of common stock per $1,000 principal amount of Exchangeable Notes, which is equivalent to an approximate exchange price of $1.875 per share of common stock.

There were a total of $550 million of these notes issued and outstanding as of the most recent 10Q, of which Liberty possessed $11 million. So, if these exchangeable notes can be converted at any time, and Liberty holds $11 million there are another $539 million that can convert to common shares by parties other than Liberty. The number of shares that would result if all $539 million were acquired through these non-Liberty notes would be 539,000 x 533.3333 = 287.5 million shares, a number less than the 302 million in the forward contract.

However, if one looks carefully, the 533.3333 is the "initial exchange rate." According to the Offering Memorandum (this link was provided in comments by both Seeking Alpha members wwtimewarp and homer985 who are much more familiar with the document than I) for the Notes, this rate can be increased between zero and 133.3333 additional shares for each $1000 Note under certain circumstances.

Adjustment to shares delivered upon exchange upon certain fundamental changes

If you elect to exchange your Notes in connection with a corporate transaction that constitutes a fundamental change described in clause (1), (2), (3) or (6) of such term the exchange rate will be increased by an additional number of shares of Sirius common stock (the "additional shares") as described below. Any exchange will be deemed to have occurred in connection with such fundamental change only if such Notes are surrendered for exchange on or after the effective date of such fundamental change and prior to the close of business on the business day immediately prior to the related fundamental change purchase date.

One of these "Fundamental Changes" occurs when:

a "person" or "group" (as such terms are used in Section 13(d) of the Exchange Act) other than Sirius, its subsidiaries or its or their employee benefit plans, files a Schedule TO or any schedule, form or report under the Exchange Act disclosing that such person or group has become the direct or indirect "beneficial owner," as defined in Rule 13d-3 under the Exchange Act, of Sirius's common equity representing more than 50% of the voting power of the Sirius common equity;

So, if Liberty goes over 50%, each of these Notes could be converted into more than the initial exchange rate of 533.3333 shares. Does it matter? From some perspectives it is important, especially if the shares underlying the notes grow from 293 million to a maximum of nearly 367 million. This should concern investors as it would represent additional dilution to the share count.

Regardless, back to the initial question. Where are the 302 million shares in the forward contract coming from? Are they coming from these Notes? I would suggest simple arithmetic indicates they are not the source of the shares.

In the recently filed 13D, Liberty provides the following information:

Sole Voting Power: 2,653,193,427 - These shares are comprised of 2,586,976,761 shares underlying the B-1 Preferred Stock, 5,866,666 shares of Common Stock issuable upon the exchange of $11 million aggregate principal amount of the 7% Notes, and 60,350,000 shares of Common Stock purchased on the open market on May 8th and 9th.

We also know that the forward contract covers an additional 302,198,700 shares, and that all of these shares represent an ownership interest of 46.2%. The last piece of the puzzle is that Liberty states in the 13D that Sirius had 3,801,029,929 shares of Common Stock outstanding as of April 27, 2012. So, how does Liberty get to 46.2%?

I would suggest the 46.2% was calculated as follows:

The first part of the equation is fairly easy and only requires we know how many shares Liberty is including:

2,586,976,761 (from the B-1) + 60,350,000 (open market purchase) + 302,198,700 (Forward Agreement) + 5,866,666 (conversion of the 7% Note) = 2,955,392,127 Total Shares.

The second part of the equation is knowing the non-Liberty shares in the total:

Start with the Sirius 10Q figure of 3,801,029,929 shares of Common Stock outstanding at the end of April. At that time they were all non-Liberty shares. Since Liberty is including the 5,866,666 from the conversion of the note, the common shares outstanding would grow by that amount. Next we know that Liberty is acquiring 302,198,700 forward agreement and has already acquired 60,350,000 shares in the open market. So, the non-Liberty shares will be:

3,801,029,929 - 60,350,000 - 302,198,700 = 3,438,481,229 shares

The total shares will be:

2,955,392,127 Liberty shares + 3,438,481,229 non-Liberty shares = 6,393,873,356

And, the Liberty percentage would be 2,955,392,127 / 6,393,873,356 = 46.2%

One might ask: "How does this prove that the 302,198,700 shares are NOT from the conversion of the 7% Notes?" The answer is that if the shares were coming from the 7% Notes, rather than the current number of shares outstanding, then the total number of shares outstanding would rise above the 6,393,873,356 total shares in the above calculation. And if the denominator increased by the 302,198,700 acquired in the forward contract, the Liberty percentage would be less than 46.2%! This is shown in the below calculations.

The revised non-Liberty common shares would be:

3,801,029,929 - 60,350,000 = 3,740,679,929 shares

The revised total shares would be:

2,955,392,127 Liberty shares + 3,740,679,929 non-Liberty shares = 6,696,072,056

And, the Liberty percentage would be:

2,955,392,127 / 6,696,072,056 = 44.1%



The 302 million shares in the Forward Purchase Contract must be coming from sources other than the 7% Exchangeable Notes. Does it matter? In many ways it is important information for Sirius investors. The 7% Notes will still be out there - or at least the $539 million held by non -Liberty owners - and they continue to represent potential dilution for shareholders. Furthermore, if Liberty triggers a clause in the Note agreement, the dilution could potentially rise by as much as 80 million shares from the initial exchange rate of 293 million shares. And, this additional dilution comes on top of insiders exercising options that continues to increase the share count.

On the positive side, removing these 302 million common shares from the public float is good news. Along with the Liberty purchase of 60 million shares, almost one tenth of the common stock has now been removed from the market.

Disclosure: I am long SIRI.

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. I hold no positions nor do I currently plan to open a position in Liberty Media.