Liberty Media's (LMCA) John Malone was quoted in several articles last week, some of which contradict each other about his feelings regarding Sirius XM's (SIRI) Mel Karmazin. However, one theme ran through all of the articles. According to Reuters, Malone wants a premium from Sirius for himself:
At the annual Allen & Co. media and technology conference in Sun Valley, however, Malone said on Thursday that if anyone was going to get a premium in a deal, it would be he.
'There are three parties in this deal -- Sirius and its shareholders, Liberty and its shareholders, and there's me personally because I am the controlling shareholder in Liberty,' said Malone. 'So when you ask yourself, "Should there be a control premium and if there is one, who should get it," don't forget about me.'
Most investors following Sirius over the past few days are familiar with this "now-famous quote." But no one seems to know how he plans to get that premium out of Sirius. Most had anticipated Sirius would do a share buyback, which would increase Liberty's ownership without any cash from Malone. However, this excerpt from the Wall Street Journal offers a clue:
In Thursday's interview, Mr. Malone displayed his frustration with Mr. Karmazin's attitude. 'What gives Mel the right to say, hey, John, you've got to go away? ... This is a John-Mel thing. Control is control is control is control. And my whole life has been about control.'
Mr. Malone said he wants Sirius to use its significant cash flow to return money to Liberty. 'If we have to spend our money to go from 40% to 50% and decide we want to spin it off, we'd like to get that capital back before we spin it off,' he said.
If Malone does try to take some of the capital from Sirius before the spin-off, this could have tax consequences. Although a Reverse Morris Trust is very complicated, and full of loopholes with many different interpretations, it is recommended that any company get IRS approval before an RMT transaction begins to avoid a huge tax bill:
The implication of the anti-Morris Trust rule is that the acquirer must be smaller than the target company, so that it ends up with a minority (less than 50%) stake in the combined company. If a potential acquirer is only slightly larger than the target, however, it may be possible to either shrink the value of the acquirer via a dividend or share repurchase, or increase the value of the target by shifting leverage to the parent prior to the spin-off.
In any case, the distributing corporation should obtain a private letter ruling from the IRS in support of tax-free treatment of a contemplated Morris Trust transaction before proceeding with the transaction.
And there have been new changes to the "loopholes" in a RMT. In March of this year, the Senate passed a transportation bill (S.1813) that had the following changes to RMT transactions buried within it:
Reverse Morris Trust transactions. Under current law, in certain corporate reorganizations involving a spin-off of a subsidiary, the subsidiary can issue its stock or debt securities in the transaction without triggering gain to the parent corporation on the transaction. This includes transactions commonly referred to as 'Reverse Morris Trust' transactions. Gain is recognized to the extent of the value of money or other property distributed by the subsidiary in the reorganization. Thus, if the subsidiary borrows and distributes cash, or assumes debt of the parent, gain will be recognized. But if the subsidiary distributes its own debt securities in the transaction, no gain is recognized even though the economic result is equivalent to the subsidiary's direct assumption of the parent's debt.
S. 1813 would treat distributions of debt securities to the parent in reorganization transactions involving a spin-off in the same way as distributions of cash or other property in the reorganization. The change would generally apply to exchanges after the enactment date, but under a transition rule the following transactions would be exempt: those made pursuant to a written agreement which was binding on Feb. 6, 2012, and at all times thereafter; those described in a ruling request submitted to IRS on or before Feb. 6, 2012; or those that are transactions described on or before Feb. 6, 2012, in a public announcement or in a filing with the Securities and Exchange Commission.
I am hoping that this will bring some lively discussion in the comments section below. I have taken a lot of graduate-level law classes, but I am admittedly not an attorney specializing in this type of law. But I interpret this to mean that unless Liberty filed an intent to spin-off Sirius via a RMT with the SEC before Feb. 6, 2012, then any distribution of cash to the parent company would be treated as a (taxable) distribution. I do not know any other way to take that. There are also some articles that indicate that RMTs have ended entirely:
Senators used the measure to raise $244 million by ending Reverse Morris Trusts, which are deals that permit companies to recognize tax-free gains from sales of spun off subsidiaries.
If that is indeed correct, then Malone will have to settle for the premium that he got when he first acquired his preferred shares of Sirius, or he will have to pay the IRS. After all, he only paid $12,500 for 40% of Sirius XM in 2009, which at $2.05 a share is now worth approximately $5.33 billion. Forty percent of approximately 6.5 billion total shares would be 2.6 billion shares converted times $2.05:
More than three years ago Liberty acquired preferred shares from Sirius for $12,500 that are convertible into 40% of the company as part of an investment agreement that included a $540 million loan that Sirius desperately needed to avert bankruptcy. Since then, the loan was paid back...
There have been a couple of headlines this morning saying that Malone wants his money back from the Sirius XM bailout. Given that the articles have no sources showing Malone actually said anything like that, I am going to assume that he did not say it. Because as I pointed out, not only was he paid back, he has made several billion dollars in profit from the transactions. And there is another premium that he has gotten. Sirius has made his Liberty stock skyrocket the last couple years compared to some of the company's other investments:
In the WSJ article quoted above, he was quite critical of Karmazin, but when I look at the chart above, Karmazin has outperformed all of Malone's companies that are represented above. The only reason that Liberty is where it is (on the chart), right below Sirius, is due to Sirius. In all fairness to Malone, in the Reuters article mentioned above he said:
Malone told reporters at Sun Valley that Liberty had no intention of taking operating control of Sirius away from Karmazin. 'I love Mel,"' he said. 'We hope he is happy.'
The premiums that Malone has already received are directly due to Karmazin's leadership at Sirius. Considering the tax uncertainty involved with an RMT, and the fact that Sirius has outperformed Liberty and its top companies, I find it difficult to understand why some investors are selling their Sirius shares and buying Liberty. If you just want to buy Liberty, that's fine. But if you want to buy it to capitalize on a Sirius/Liberty Merger, I would investigate it further.
Disclosure: I am long SIRI. I will continue to buy SIRI on the dips.