Liberty Media Pays A Premium For Sirius XM Shares

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 |  Includes: LMCA, SIRI
by: Crunching Numbers

The latest round of FCC filings by Liberty Media (NASDAQ:LMCA) and Sirius XM Radio (NASDAQ:SIRI) have revived speculation about the size of a premium Liberty would have to pay to gain control of Sirius XM. Based on comments on Seeking Alpha, there are a significant number of retail investors that think Liberty going to a majority position will require it to pay a large premium for Sirius XM shares and/or that Liberty won't be willing to open its wallet and pay cash to go to a majority position. The recent actions by Liberty and the market's reaction suggest otherwise.

Will Liberty Pay a Premium?

When Liberty entered into a forward contract to purchase up to 315 million shares of Sirius XM on December 30, 2011 the shares of Sirius XM closed at $1.82. The contract is now scheduled to settle on July 11th, and cover 302,198,700 at a cost of $650 million or about $2.15 per share. In addition, Liberty made open market purchases for another 60.35 million shares at a cost of just over $128 million, or just under $2.13 per share. Looking at the $1.82 share price at the time the forward contract was executed and the eventual purchases, it could be argued that Liberty has already paid a premium of 18% to acquire nearly 10% of the Sirius XM common shares.

Clearly, this is not the type of near-term "premium" many investors were expecting. It should also be clear that if Liberty was willing to pay nearly $0.8 billion to increase its ownership stake by just over 6% of the company (bringing its total to 46.2%), than it should have no issue spending another $0.7 billion to get to a majority position.

It has been a month since the shares of Sirius XM closed above $2.00. At the current time the shares are trading at $1.84, not far from the closing price of $1.82 when Liberty entered its forward contract. And, with Karmazin's 10b5-1 planned sale likely to put more pressure on the share price later this week, it seems unlikely that the price will be moving sharply higher in the near term. These factors make it seem unlikely that Liberty would have any problems acquiring the remaining 4% needed to take control at the price levels previously paid - up to $2.15 per share.

The FCC Decision

The key player in a Liberty takeover of Sirius XM will not be Liberty's Chairman John Malone, its CEO Greg Maffei or Sirius XM's Karmazin, but the FCC. The FCC will have to decide if the recent moves by Liberty to increase its ownership to 46.2% and its proposed strategy to take control of the Sirius XM board are sufficient to waive the electronic filing requirements. In its previous rejection, the FCC wrote:

Furthermore, we conclude that a waiver of basic filing requirements is not warranted, as the facts disclosed in the referenced applications are not sufficient to establish that Liberty Media intends to take actions, such as conversion of preferred to common stock and installation of a board majority, that would constitute exercise of de facto or de jure control.

The FCC could choose:

  • to reject the application based on the view that the latest proposal is still insufficient because it is not a commitment to take control,
  • detail additional requirements before consideration (such as actual conversion of a portion or all of Liberty Media's preferred shares),
  • require concrete commitments by Liberty,
  • grant de facto control provided Liberty Media agrees to certain conditions, or
  • simply grant de facto control.

Regardless of the route the FCC chooses to take, Liberty has made its intentions fairly clear. It wants control of Sirius XM and is willing to use its cash to effect a takeover.

The Sirius XM Response

Sirius XM, as expected, filed a response to the Liberty submission for reconsideration. Sirius XM arguments included the following: that Liberty has not actually converted any of its preferred shares, has only purchased 60.35 million shares, has not submitted a schedule for with dates when any of these actions will take place or proposed a slate of directors. The FCC will have to decide which, if any, of the Sirius XM arguments have merit and what steps Liberty would need to take to gain approval.

Interestingly, not one of the arguments was about the most critical factor - the suitability of Liberty to control the licenses.

How to Safely Invest in This Environment

With the uncertainty surrounding the Sirius XM shares, is there a way to invest with a reduced level of risk? If one is willing to forgo some potential upside while at the same time lowering the cost of their investment, there is a short term play using options that can generate a return of close to 20%.

If one buys into the assumption that Liberty, an insider, saw fair value at $2.15, that would indicate that the shares will trade back to that price. This creates a potential gain of $0.31 from the current level of $1.84 back up to $2.15, and if the shares do climb to that level, the gain would be 16.8%. Alternatively, an investor can open a covered call position by purchasing the stock at $1.84 and simultaneously writing a January 2013 call at the $2 strike price. These calls are currently trading at $0.17 Bid. Opening the covered position would lower the net cost to $1.67 per share ( $1.84 - $0.17 call premium), reducing an investor's exposure and downside risk. If the shares are trading above the $2 strike price on January 19, 2013 (the option expiration date), the position would be called and a gain of $0.33 per share would be realized.

The percentage gain on the transaction is nearly 20%:

( ($2.00 strike price - $1.67 net cost ) / $1.67) = 19.76%

For a new straight long position opened at $1.84, the shares would need to go to $2.20 to return the same 19.76%. On a cash basis per contract, the "breakeven" would be $2.17 ($2.17 - $1.84 = $0.33 per share). The downside is that should the shares climb above $2.17 - $2.20 on the January expiration date, potential profits above those levels would be forfeited.

Summary

Liberty has clearly laid out its plans to take control of Sirius XM. Based upon the level of shareholder participation in shareholder votes, it is not even clear whether or not Liberty will need to acquire additional shares to install its own slate of directors.

And, even if additional share purchases are required, it is difficult to envision a scenario where Liberty would be required to pay a premium beyond the approximately $2.15 per share it has already paid. Using the covered call strategy outlined above, an investor has an opportunity to reduce risk and achieve a 20% return in just seven months. And to get this 20% return, the shares only have to trade to $2, not $2.20, or even the $2.15 Liberty was willing to pay!

Disclosure: I am long SIRI. 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 have made similar covered call trades to those discussed and may initiate (or close) a buy stock/sell option position in Sirius, at any time. I have no positions, or any plans to open positions in the next 72 hours, in Liberty Media.