Friday, July 6th, Liberty Media's (LMCA) forward contract with an unnamed party to purchase 302,198,700 shares of Sirius XM (SIRI) expires. And, on July 11th, the two parties will settle up. Either Liberty will back out of the agreement, or it will take delivery of the shares. The likelihood is that Liberty will take delivery of the shares by making a significant additional cash payment. These shares, along with Liberty's preferred shares, convertible debt, and its open market purchases of 60.35 million shares in early May, will give Liberty an ownership stake of approximately 46.2%. It will also mean that Liberty now has a substantial amount of hard cash tied up in its Sirius XM investment.
The forward contract will require total cash payments in excess of $650 million, and its additional open market purchases cost Liberty an additional $128.5 million. The total, with fees, could exceed $0.8 billion. Compare that to the purchase of 40% of Sirius XM for $12,500 as part of a loan package that Liberty made to Sirius XM more than 3 years ago. Many investors in both companies are probably trying to figure out exactly what Liberty intends to do.
If Liberty management had been satisfied that the Sirius XM management was doing an excellent job and taking Sirius XM in a direction to maximize shareholder value, there would have been little reason for Liberty to increase its ownership stake and to try and take control of Sirius XM. Further, if Liberty thought that Sirius XM had no future, it could liquidate its stake, pay some taxes and move on. Or, Liberty could have taken an in-between path and simply converted its preferred shares to common and distributed those shares to Liberty stockholders and let the shareholders decide whether an investment in Sirius XM is right for them. (The conversion of the preferred shares and the potential distribution of those shares to Liberty stockholders does not create a taxable event.)
Liberty currently has both its chairman, John Malone, and its CEO, Greg Maffei, sitting on the Sirius XM board. As a result, Liberty management has significant visibility into the strategic directions the current Sirius XM management is taking the company. With Liberty seeking to take control of Sirius XM, it could reasonably be assumed that Liberty management wants Sirius XM to move in a different direction, or that Liberty thinks that it can run Sirius XM better than the current management of Sirius XM.
Reverse Morris Trust
There are probably many investors who wish they had never heard of a Reverse Morris Trust ("RMT"). It is a complex transaction with tax advantages that provide a justification for its use. It has been suggested that Liberty will use this section of the tax code to gain control of Sirius XM in a tax efficient manner in order to use the nearly $8 billion of Sirius XM NOLs. While Liberty may use the RMT in its presumed takeover, it is unlikely to use the RMT to directly access the NOLs since that would require that Liberty acquire 80% of Sirius XM.
We know that it cost Liberty about $.8 billion to go from just over 40% to just over 46%, so, acquiring the additional 34% get to 80% could cost an additional $4-$5 billion or more. For the NOLs to provide enough of a benefit to justify this incremental investment by Liberty, Liberty would need significant non-Sirius XM Operating Income that would dramatically accelerate the use of those NOLs. It is difficult to envision such a scenario.
There is another way that a company can monetize an investment using the RMT. The RMT requires that Liberty establish a separate entity (for simplicity, call it "NewCo") and put assets into NewCo. Then, Liberty would put its Sirius XM holdings into NewCo. Liberty could also put other assets - such as the Liberty stake in Live Nation (LYV) - into NewCo, although it is not necessary. The transaction, up to this point, does nothing to monetize Liberty's investment. But, Liberty can also have NewCo take on debt (subject to certain limitations) and distribute the cash to its parent, Liberty, in a tax-free transaction prior to its separation from Liberty. At this point, Liberty has monetized a portion of its investment tax-free and NewCo can merge with Sirius XM and distribute shares of Sirius XM to the owners of NewCo.
After the RMT
For more than a year, investors in Sirius XM have been waiting for the company to announce its plans for the use of the company's cash. Many had been hoping for that use to be a share buyback in order to reduce the number of shares outstanding. To date, the company management has been reluctant to institute a buyback because it would increase Liberty's ownership percentage, and instead has embarked on a path to pay down debt.
With Liberty heading towards a majority ownership position on its own, this concern goes away. Will the completion of the RMT mean Sirius XM will now use its substantial free cash flow - expected to reach $700 million this year - and cash balances to finally institute a buyback? Maybe, but if the RMT means NewCo brings significant new debt to Sirius XM, paying down debt could remain a priority and push a share buyback further into the future.
Liberty has stated it thinks Sirius XM should bring some additional focus to the Internet space and that it would be comfortable with Sirius XM leveraging up the balance sheet. Whether or not the current shareholders of Sirius XM would benefit from these actions and a potential change in ownership or management remains to be seen. And, if Liberty is successful in taking control of Sirius, goes through an RMT, pulls cash out and puts debt into NewCo, at least its objective of leveraging up the balance sheet would be accomplished.
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, at any time. I have no positions, or any plans to open positions in the next 72 hours, in any of the other companies mentioned in this article.