Sirius XM Share Dilution: A Look At The Rumors

| About: Sirius XM (SIRI)

There have been numerous articles, comments and internet postings claiming that Sirius XM (NASDAQ:SIRI) shares will be diluted, and/or near worthless when (and if) Liberty Media (NASDAQ:LMCA) converts its preferred shares of Sirius to common shares; and then implements a Reverse Morris Trust RMT transaction. Those Liberty preferred shares represent over 40% of the total value of Sirius. According to Investopedia, the definition of stock dilution is:

A reduction in earnings per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities.

I think most investors know this, but they are getting confused between dilution and a large amount of Sirius shares hitting the market at one time. That is not dilution. That is actually a case of supply and demand. The supply of shares suddenly exceeds the demand of investors wanting to buy the company. Dilution on the other hand would be like taking a glass of lemonade and adding water to it. It is now not the same product regardless of price. If it did have a price, you would gladly pay more for a glass full of regular lemonade without the water added. The supply and demand issue would involve more lemonade on the market (at full strength) than people to drink it.

From the Sirius XM 2011 Annual Report (10k) released on February 9, 2012, the operations statement shows the earnings per share of the common stock, and the diluted earnings per share which include Liberty's 40% ownership. It also shows the common shares outstanding, and the common shares outstanding diluted:

As of and for the Years Ended December 31,
2011 2010 2009(1) 2008(1)(2) 2007
(in thousands, except per share data)

Statements of Operations Data:

Total revenue

$ 3,014,524 $ 2,816,992 $ 2,472,638 $ 1,663,992 $ 922,066

Net income (loss) attributable to common stockholders

$ 426,961 $ 43,055 $ (538,226 ) $ (5,316,910 ) $ (565,252 )

Net income (loss) per share - basic

$ 0.11 $ 0.01 $ (0.15 ) $ (2.45 ) $ (0.39 )

Net income (loss) per share - diluted

$ 0.07 $ 0.01 $ (0.15 ) $ (2.45 ) $ (0.39 )

Weighted average common shares outstanding - basic

3,744,606 3,693,259 3,585,864 2,169,489 1,462,967

Weighted average common shares outstanding - diluted

6,500,822 6,391,071 3,585,864 2,169,489 1,462,967

Balance Sheet Data:

Cash and cash equivalents

$ 773,990 $ 586,691 $ 383,489 $ 380,446 $ 438,820

Restricted investments

$ 3,973 $ 3,396 $ 3,400 $ 141,250 $ 53,000

Total assets

$ 7,495,996 $ 7,383,086 $ 7,322,206 $ 7,527,075 $ 1,687,231

Long-term debt, net of current portion

$ 3,012,351 $ 3,021,763 $ 3,063,281 $ 2,820,781 $ 1,271,699

Stockholders' equity (deficit)(3)

$ 704,145 $ 207,636 $ 95,522 $ 75,875 $ (792,737 )
Click to enlarge

Earnings per share will only change if the share count, or the earnings, change. As you can see the number of shares at the end of the year was 3,744,606 (reported in thousands), or 3.75 billion shares of common stock. The diluted share count, which is Sirius common shares and Liberty preferred shares (if converted) combined, was 6,500,822, or 6.5 billion shares total (diluted). These numbers can change somewhat (both up and down) with the conversion of securities, employee 401-k transactions, share buybacks, etc.

The earnings for 2011 were $427 million. This number is then divided by the total number of shares to get the earnings per share EPS. This is stated on the report as 11 cents a share regular, and 7 cents a share diluted. That 7 cents a share is what is reported in analyst's articles, and target price calculations. So whether or not the Liberty shares are converted, the EPS is still 7 cents. The only thing that can change that is if shares are issued or retired, not converted; or if the earnings change. And the earnings are expected to change in a very big way! Here are what I consider to be very conservative estimates from Yahoo Finance:

EPS Trends Current Qtr.
Jun 12
Next Qtr.
Sep 12
Current Year
Dec 12
Next Year
Dec 13
Current Estimate 0.02 0.02 0.08 0.11
7 Days Ago 0.02 0.02 0.08 0.11
30 Days Ago 0.02 0.02 0.08 0.11
60 Days Ago 0.02 0.02 0.08 0.11
90 Days Ago 0.02 0.02 0.07 0.11
Click to enlarge

These numbers are based on (and always have been) the possibility of Liberty converting its shares to common stock (diluted). So it does not matter whether Liberty converts or not, it will not change the earning per share. Thus per the definition of dilution, the stock will not become diluted with a Liberty conversion. As you can see, when the estimates are broken down on the chart below, the high for 2012 may be 10 cents a share, and 2013 could go to 15 cents a share. The earning for Q2 will be announced on August 7. That will give us a clue as to how 2012 will end. Since the additional sub count of 622 thousand for Q2 was up 38% over last year, we can assume that the earnings may be historically high. If you are not "all in" right now, you might seriously consider it before the earnings are made public.

Earnings Est Current Qtr.
Jun 12
Next Qtr.
Sep 12
Current Year
Dec 12
Next Year
Dec 13
Avg. Estimate 0.02 0.02 0.08 0.11
No. of Analysts 14.00 14.00 15.00 13.00
Low Estimate 0.01 0.01 0.03 0.05
High Estimate 0.02 0.03 0.10 0.15
Year Ago EPS 0.03 0.02 0.07 0.08
Click to enlarge

Next Earnings Date: Aug 7, 2012.

So now you see that the Liberty conversion will NOT dilute Sirius XM shares. But there is another rumor that is circulating. And that is the scenario that the shares will be diluted with the creation of a Reverse Morris Trust or RMT by Liberty. Although the author of the following quote did not mention the word dilution, it was implied:

This is a big deal because currently Sirius XM has 3.34B floating shares. With a flood of 2.83B shares hitting the market, there may likely be a strong movement for Liberty Media shareholders to sell off their position in Sirius XM.

It can and will be argued that these new shares that will hit the market are already taken into account for the market cap, float etc. However, I know that If I were distributed shares of 'Sirius Holdings' then I would give some serious thought to selling them in the open market.

First of all this is a case of supply and demand. The author believes that a huge supply of Sirius stock will hit the open market after a theoretical RMT happens. It would help to see who the current owners of Liberty are. Because technically it would be the new Liberty stock being sold, and according to the above article, becoming worthless due to the sudden huge supply. Here are the current major owners of Liberty Media according to Yahoo:

% of Shares Held by All Insider and 5% Owners: 9%
% of Shares Held by Institutional & Mutual Fund Owners: 85%
% of Float Held by Institutional & Mutual Fund Owners: 93%
Number of Institutions Holding Shares: 384
Click to enlarge

Major Direct Holders (Forms 3 & 4)

Click to enlarge
Holder Shares Reported
MALONE JOHN C 1,852,300 Jul 4, 2012
MAFFEI GREGORY B 506,302 Dec 29, 2011
BENNETT ROBERT R 6,292 Dec 14, 2011
FLOWERS DAVID J A 111,292 Sep 22, 2011
TANABE CHARLES Y 44,701 Jun 14, 2012
Click to enlarge

As you can see almost the entire company is owned by five Liberty insiders, and 384 institutions. And they absolutely will NOT sell their stock. Those shares are locked in. How can I be so sure? First of all not one of these owners wants to pay taxes. The purpose of an RMT is to get ownership without having to sell and pay taxes. And if there are any of these guys who do not see the golden future Sirius XM has, they will have plenty of analysts on the payroll to point it out. Secondly if we study what happened in the Directv (DTV)/Liberty RMT, it becomes clear what path Liberty wants to take.

There is an excellent article written in February of 2011 which discusses the DTV RMT and its implications involving a Liberty/Sirius merger. According to the author, Liberty bumped up its ownership in DTV from 48% to 54% through DTV share buybacks. As I have written in numerous articles, I think this was Liberty's plan for Sirius. However, Sirius CEO Mel Karmazin blocked that idea. If and when Liberty takes control of Sirius, share buybacks will be the first thing on the agenda. The historical changes in the DTV stock due to the Liberty takeover were only positive. When Liberty shareholders got their new Liberty/DTV stock, they did not sell it. The transaction took place on November 19, 2009, after the announcement in May 2009. The share price of DTV was $24.18 the first of January 2009. After the RMT was announced in May it was $22.50. As you can see the shares went up (not down) in November (19th) when the deal closed:

Dec 4, 2009 32.22 32.73 31.93 32.66 16,203,700 32.66
Dec 3, 2009 31.50 32.15 31.42 31.90 9,768,400 31.90
Dec 2, 2009 31.40 31.78 31.10 31.56 9,021,100 31.56
Dec 1, 2009 31.82 32.18 31.40 31.50 16,014,200 31.50
Nov 30, 2009 31.26 32.15 31.05 31.63 12,915,000 31.63
Nov 27, 2009 30.95 31.79 30.95 31.60 7,635,200 31.60
Nov 25, 2009 32.00 32.07 31.79 31.89 9,664,400 31.89
Nov 24, 2009 31.83 32.30 31.57 31.91 19,503,600 31.91
Nov 23, 2009 31.81 31.87 31.39 31.59 16,988,300 31.59
Nov 20, 2009 31.40 32.07 30.88 31.54 37,610,600 31.54
Nov 19, 2009 31.24 31.80 30.29 31.50 114,071,900 31.50
Nov 18, 2009 31.00 31.25 30.64 31.04 31,202,400 31.04
Nov 17, 2009 30.29 31.01 30.08 30.93 25,831,900 30.93
Nov 16, 2009 29.94 30.42 29.66 30.31 18,793,300 30.31
Nov 13, 2009 29.59 30.04 29.24 29.82 12,441,700 29.82
Nov 12, 2009 29.57 29.75 28.91 29.07 10,675,100 29.07
Nov 11, 2009 29.50 30.07 29.18 29.44 15,723,000 29.44
Nov 10, 2009 28.72 29.16 28.55 29.11 18,624,000 29.11
Nov 9, 2009 28.80 29.07 28.42 28.57 17,665,600 28.57
Nov 6, 2009 28.48 29.42 28.04 28.59 24,740,700 28.59
Nov 5, 2009 26.48 28.75 26.10 28.54 43,757,300 28.54
Nov 4, 2009 26.64 27.66 26.22 26.84 15,191,800 26.84
Click to enlarge

DTV ended the year (2009) at $33.35, up 38%. If the price of Sirius were to go up 38%, the new price would be $2.91. And as I have pointed out, with a share buyback which would remove some of the actual dilution, the price could go over $3.50 very quickly.

Chart forDIRECTV

There is one more point to consider. Liberty still must get FCC approval for any of this to transpire. According to the last FCC rejection of Liberty's application for de facto control of Sirius, the company must accomplish "installation of a board majority", and take total control of Sirius. Currently, Mel is blocking a share buyback which would give Liberty additional ownership at no additional cost. So unless Mel changes his mind, or the FCC breaks tradition and considers 46.2 to be the new 50.1, Liberty will have to buy more shares to get hard control, or 50.1%, of Sirius. If Mel is still opposed to the takeover, and the FCC does rule that a company can perform a hostile takeover without purchasing the majority of the target company, it would set a precedent for anyone to do the same thing. So I would not bet real money on this happening.

At last count, Liberty owned 46.2% of Sirius. Based on the total diluted shares of 6.5 billion, this would be approximately 3 billion shares. That is about 260 million shares short. With the new average daily volume of Sirius shares at just over 30 million, that would take almost two weeks to purchase, if Liberty were the only one buying. And we know that is not the case. Combined with the expected jump in earnings to be announced on August 7, and the current short position of 290 million shares (two additional weeks to cover), Sirius XM longs may see the price skyrocket. And unless Liberty has already made another forward agreement, or purchased more stock on the open market, they may be out of luck. But either way, with or without Liberty, the price of Sirius stock is headed way up.

Disclosure: I am long SIRI.

Additional disclosure: I may buy Sirius XM stock in the next 72 hours.