The last few months have certainly been interesting if you are invested in Liberty Media (NASDAQ:LMCA) or Sirius XM Satellite Radio (NASDAQ:SIRI). The gears that were set into motion three years ago have finally made their full cycle turn and investors in both equities are trying to determine the outcome.
From FCC licenses, to board seats, to Net Operating Losses, to Reverse Morris Trusts, there certainly has been a lot to consider. Now toss in forward contracts and a couple of open market purchases by Liberty and you have a recipe for investor confusion.
There are some key elements that investors need to understand. Some of these elements will have elements that may seem controversial, but I assure you that when I offer up an opinion it is done so based on a lot of information and consideration.
The Net Operating Losses
Sirius XM has some highly valuable Net operating Losses that they have spent years protecting. Many investors have expressed concern over these NOL's and how they might be impacted based on what Liberty media does. The first thing investors need to realize is that if Liberty goes over 50% the NOL's are not lost, nor is a new testing period started. The NOL's will remain exactly as they are, and no value or ability for Sirius XM to use them will be lost. This should give SIRI investors a bit of confidence surrounding this issue.
The only real manner in which Liberty Media can access the NOL's is if they go to an 80% stake in Sirius XM and then further negotiate their use with the company. In my opinion the NOL's are not really the main goal for Liberty. Liberty gains much more value in conducting a Reverse Morris Trust.
Reverse Morris Trust
This would seem to be the main goal for Liberty Media, and perhaps the biggest source of confusion for Sirius XM shareholders. In essence a Reverse Morris Trust can happen when Liberty takes a majority position in Sirius XM. At that point Liberty can spin off their Sirius stake to the Liberty shareholders and merge that spin-off into the smaller Sirius XM, with the smaller company being the surviving entity.
A Reverse Morris Trust can not happen without negotiation. Even if Liberty were to elect their own board after they got above a 50% stake, there would be a few items that will ensure value for minority shareholders.
In that situation Liberty would likely conduct a "fairness opinion" where a consulting firm comes in on behalf of minority shareholders to help determine if the minority holders are being treated fairly. In addition, putting matters to a vote will also help determine fairness. If a majority of the minority approve a matter, it becomes more difficult for litigation or challenges to happen.
In a recent post I wrote about theoretical board seats and board control. There are so many variables at play that I neglected to consider one very salient point. Once Liberty has over 50% in common shares they can nominate and elect their own board slate. The company does not need to get to 54%, although getting to a comfortable level above 50% would be prudent (due to convertibles, warrants, options, etc.)
The basic mechanism is this. Once Liberty is at 50%, they can simply write a letter nominating a new Board of Directors.
The current board is made up of Common Directors and preferred Directors. There are 8 common seats, and 5 preferred seats. Interestingly, Liberty has a bit of a quandary. With their preferred shares, they can not vote on common directors. The only way they can vote common directors, or effectively nominate their own slate is to convert their preferred stake to common. If Liberty does this they may lose other rights that they currently have.
The Liberty preferred shares give the company some very specific rights and powers. Essentially, with the preferred stake, Liberty has veto power over use of cash, dilution, debt, and other activities. Liberty Media can maintain all of these rights as long as they keep at least half of their stake in preferred shares. The trick here is that if they only convert half, they would have about 26.2% of the company in common shares (giving credit for the forward contract shares and the open market purchases made so far). This would likely be enough to sway their own board slate, but surprises can happen.
In my opinion Liberty could well make the move to go to at least 50% on an as converted basis, and will move to a comfortable level above 50% to deal with any possible converts, warrants, etc. I see Liberty working as much as possible to keep things at a level of fairness that will avoid delay. Look for proposals that will win over a majority of the minority. While this may be a bold statement, it is quite possible that Liberty makes some move sooner rather than later. At this point they can't sit back and relax.
Stay tuned, things are getting very interesting.
Disclosure: I am long SIRI.
Additional disclosure: I have no position in LMCA