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As the drama between Liberty Media (NASDAQ:LMCA) and Sirius XM (NASDAQ:SIRI) continues to play out, more and more investors and analysts are beginning to contemplate what the best satellite radio play is. If you are seeking an investment in satellite radio should you put your dollars to work with Sirius XM, or should you jump into Liberty Media? The question gets even more interesting for current holders in Liberty Media, and especially longs on Sirius XM.

Today Barclay's James Ratcliffe broached this very subject in a report that looked at both Liberty as well as Sirius XM. Perhaps it is best to simply look at the ratings Ratcliffe assigned first.

Regarding Sirius XM, Ratcliffe has moved his rating from Equal Rate to Underweight, a very respectable move considering the recent upside swing in the stock of the satellite radio provider. Essentially, even with a big positive push lately, Ratcliffe is saying that there is more upside to come. Ratcliffe's new price target on Sirius XM is $2.25, up from $2.00. This represents an imlied 12.5% upside.

Regarding Liberty Media, Ratcliffe has moved the rating from Overweight to Equal Rate. This upgrade is saying that the current trading levels of Liberty are now reasonable. Liberty has also seen a recent surge in price so again, the upgrade carries impact. Ratcliffe moved his price target on Liberty Media to $108.00 from $98.00, an implied 10% upside.

So what drove these upgrades? Part of it has to do with what is anticipated to be a very good quarter and year for Sirius XM, and on the Liberty side it relates to Liberty's substantial holding in the satellite radio provider.

"We continue to find the long LMCA/short SIRI trade attractive (even though the spread has been reduced), but now also view LMCA attractive as a simple long (and the best way to get exposure to SIRI shares), due to our more positive view on SIRI."

Simply stated, If Sirius XM's outlook is positive, the outlook for Liberty will be positively effected as well. Interestingly though, the recommended trade outlined by Ratcliffe involves going long Liberty Media and short Sirius XM.

So which way should an investor go? That is the question many are posing. Unfortunately there is no simple answer to that question, as any answer involves speculation. That speculation carries wide ranges of opinion from Liberty simply cashing out and walking away, to a Reverse Morris Trust without getting to 51%, to a controlling interest at 51% and then a Reverse Morris Trust, to and 80% stake chasing the benefit of billions in Net Operating Losses (NOL's), to total control.

The most common speculation is that Liberty will pursue a tax friendly Reverse Morris Trust. For months this has been the mainstream speculation and has fueled the fires that Liberty would need to take a 51% stake in Sirius XM. The reasoning is that one integral part of a Reverse Morris Trust is that a larger company merges into a smaller one with the smaller one being the surviving entity. Thus, Liberty would need to go to 51% in order to be the larger company. However, another possibility exists. Liberty could combine its 46.2% stake in Sirius XM with another holding such as Live Nation (NYSE:LYV) to spin off a company that is bigger than the current 53.6% Sirius XM. This would qualify as a larger company merging into a smaller one. Of course, any Reverse Morris Trust need the approval of the Sirius XM Board, which brings to light the issue of whether Liberty makes a move to install a new Board of Directors (another topic hotly debated).

With a Reverse Morris Trust, the most common question I get is whether an investors Sirius XM shares will still exist. The simple answer is yes. The more complex answer is that the companies can do a whole lot of shifting in a merger, with some of that shifting being how the deal is structured in terms of shares.

According to Ratcliffe, the situation is this:

"We believe both LMCA and SIRI management would like to complete a distribution of SIRI shares to Liberty shareholders, due to the tax advantages for Liberty and the removal of a controlling/interfering shareholder from the perspective of SIRI management. The core stumbling block to completing [a Reverse Morris Trust] is price, but we continue to believe an announcement or at least a defined path to an RMT will be given by the end of the year. We also believe Liberty maintains the upper hand in negotiations because it can assume control at time, given its existing 46% ownership stake. We would expect the resolution of an RMT to lead to substantial buybacks of SIRI stock, which could be as high as $1 billion/year, assuming current expectations for [free cash flow]."

Thus, the issue boils down to premium. There was a time when it seemed that Sirius XM would get at least a small premium to get such a deal done. That feeling existed because Liberty Media was a 40% stakeholder at the time and would require a substantial number of shares to accomplish the desired goals. That all reversed course when it was announced in May that Liberty Media had entered into a forward purchase contract for 302 million shares and then added another 60 million on top of that with open market purchases. Suddenly the 40% stake became a 46.2% stake and Liberty Media is now only a hop, skip, and jump away from actual control. Suddenly the upper hand held by Liberty looked even better than before.

Now the situation may be that Sirius XM will have to pay the premium to Liberty. For investors that like research, Liberty Media did receive a small premium in its Reverse Morris Trust deal with DirecTV (NASDAQ:DTV).

So it boils down to which is the better satellite radio play, Liberty or Sirius XM. A lot of that depends on your opinion of where the premium might be placed, and what you believe the endgame to be.

I have been of the school of thought that a Reverse Morris Trust is the end game here. I have also been of the school of thought that Liberty carries the cards. With its preferred stake Liberty has substantial "veto" power over the use of cash, debt issues, as well as the issuance of shares. These Liberty rights contain considerable influence. Let's look at the premium issue:

  • If you are invested in Sirius XM and SIRI gets the premium you get added benefit.
  • If you are invested in Liberty and LMCA gets the premium you get added benefit.
  • If you are invested in both companies and one or the other gets the premium you get a more modest benefit, but you are guaranteed at least something

Personally, I made the move a few weeks ago to sell half of my SIRI and invest that money into LMCA. By doing so I removed some of the control drama risk from the equation, but also virtually guaranteed that I will get at least some of the benefit of a premium when that issue is negotiated between Liberty and Sirius XM. The beauty in this is that investors may not need to make an instant decision on this matter. We should get some additional clues as to the control issue any time from the FCC. Should the FCC approve Liberty's request for de facto control, then we have a small amount of time to make a decision on the eventual outcome. Should de facto control be denied, we can virtually bet that Liberty will move to de jure control and insert its own Board of Directors. Again, that move takes time, giving investors opportunity to adjust accordingly.

What is beautiful here is that analyst opinions, even the more bearish ones, are swinging to the upside for both companies and investors have time to make adjustments as they see fit. Happy trading

Disclosure: I am long SIRI, LMCA.

Additional disclosure: I have no position in Live Nation or DirecTV