If you are invested in Sirius XM (NASDAQ:SIRI) or Liberty Media (NASDAQ:LMCA), then you are well aware of the issues currently brewing in the world of satellite radio. Essentially Liberty Media has a huge 46.2% stake in Sirius XM and has expressed a desire to explore ways to best capitalize and/or monetize that stake.
I have written several pieces regarding the possibilities of a Reverse Morris Trust. In simple terms it is when a larger company merges into a smaller company with the smaller company being the surviving entity.
What has become a common misconception, especially among Sirius XM investors, is that Liberty Media must take control of Sirius XM in order for it to meet its desired goals. This is only partially true. In order to better understand the many possibilities that exist, it is likely best to look at the situation from the Liberty perspective since it is Liberty that holds the cards:
Liberty Needs To Go To Above 50% To Enact Its Goals
This is not at all true. Liberty can make several moves without ever getting to a stake above 50%. This can be accomplished in several ways:
1. Liberty can find a willing partner or partners with substantial holdings to side with them. Actually Liberty may not even need a willing partner. With its stake in Sirius XM Liberty currently has common shares that equate to 6.2% of the company. It also has preferred shares (votable on all issues except the election of Board Members) that upon conversion would equate to 40% of the company. Liberty can maintain all of its "veto" rights the preferred shares offer by maintaining just half of those shares. Thus, Liberty could convert half of the preferred and have about a 26% stake that is votable on a Board election. That number of shares alone would carry more votes than any board member has received in several elections. If Liberty wanted a bigger guarantee of the outcome, it could solicit partners. Yes, Liberty would lose a couple of Board seats with the conversion, but if it can install a Board to its liking, then the lost seats are not material.
2. Liberty can bundle its current 46.2% stake in SIRI with something else and create a larger entity. In order to conduct a Reverse Morris Trust a larger entity needs to merge into a smaller one. In this situation that larger entity does not need to be solely the Sirius XM stake. It can be the SIRI stake combined with something else. For this example I will use the Liberty stake in Live Nation (NYSE:LYV). Live Nation is a $1.6 billion company. If Liberty were to go to 50% ownership in Live Nation, the market cap of the combined Liberty stakes in Live Nation and Sirius XM would be larger than the existing Sirius XM. With this, Liberty would be free to negotiate a merger deal with the now smaller Sirius XM. The Sirius XM Board (which at this point may well be a Liberty Media installed Board) would be free to consider offers such as this. If the matter goes to a shareholder vote, Liberty would have its entire stake to vote with, plus any friendly partners. The goal would be to get a majority of the minority.
3. The FCC could grant de facto control even with the Liberty stake at less than 50%. This can happen because Liberty has tremendous control over Sirius XM, and even more control if it inserts its own Board of Directors. The goal of Liberty would be to exert that control without full conversion of the preferred stake. That preferred stake gives Liberty extensive "veto" rights over share dilution, spending of cash, and issues surrounding debt. In fact, Liberty can hold back the early repayment of debt if the cash expenditure or debt issue go above certain thresholds.
Sirius XM Will Not Do A Share Buyback If It Helps Liberty Media
With this situation, Liberty is in the driver's seat. If Sirius XM buys back shares and Liberty does not participate, the Liberty Media percentage of ownership will increase. This will take Liberty Media closer to de jure control. The classic stance has been that Sirius XM will not "help" Liberty. This is likely very true with the current Board of Directors, but will that be the case if Liberty installs its own Board? Again, this is where terms like "Fairness Test" and "Majority of the Minority" come into play. It does not matter how passionate an individual feels about this situation. If the majority of the minority votes to approve a share buyback, then it can happen. Even with the current Board of Directors a share buyback is possible. Why would the current Board seem to reverse its thought process? Because the situation changes. Liberty and the current board could come to a workable deal that includes a share buyback as a way of offsetting various premiums Liberty may seek in a Reverse Morris Trust merger. In fact, it is possible that Sirius XM could even reverse its tact on objecting to the FCC giving Liberty Media de facto control. It all boils down to the deal.
Liberty Media Already Got Its Premium
This is perhaps one of the more common themes that passionate Sirius XM longs rant about. It seems that there is a group that feels that Liberty getting the 40% stake when times were tough was premium enough. Not so at all. Liberty offered a loan in return for a healthy interest rate and a 40% stake in the company in the form of preferred shares that gave certain rights. In addition, Liberty was made exempt from a poison pill.
What Liberty has now is substantial leverage and preferred shares, that because of the rights they have, are worth much more than common stock. If Sirius XM wants the preferred shares gone, it will likely have to pay a nice premium to do so. There is no reasonable business person that, if they themselves held these preferred shares. would not demand a premium for them as well.
Yes, Liberty got to sit back and enjoy the ride up. Guess what...So did every other common investor that took the risk to buy into SIRI at that time. Would you as a common holder say that you have received premium enough for your shares and forego any price appreciation from here forward? I think not. What Liberty has is substantial leverage, and Liberty is using it.
Liberty Gets Hurt By A Delay
Some feel that delay will hurt Liberty. This is not really the case. Liberty can appreciate from good quarters of Sirius XM in just the same way long term investors do. Liberty could be hurt if it needed cash from its Sirius XM stake to do another deal, but likely even that is not the situation. Liberty Media has a lot of cash, and access to a lot more. At this point a delay could present more frustrations and hurdles, but the end game will not really change. In the meantime, with each additional step Liberty takes, the "premium" may indeed increase. More leverage equals more premium.
The FCC Holds The Key
The FCC does indeed hold the key. However, it is perhaps not the key that many think it is. What Liberty Media is really after is permission to gain control of Sirius XM. There is no reason at all that the FCC would deny Liberty Media the right to own Sirius XM. If Liberty gets de facto control, several paths open up and present an easier course to navigate. If the FCC denies de facto control, Liberty would simply move forward with other plans that result in similar result anyway, albeit more costly and more time consuming. Both cost and time become "claims" for a bigger premium or better deal.
The Liberty Premium Will Be In Shares
This could be the case, but we need to remember that Liberty's John Malone is a big player in this. Malone likes control and he will likely want some form of control that affords him 25% or so of the voting rights. This could be another class of shares or simply maintaining the preferred stake with some rights adjusted.
Liberty Media has outlined many of these possibilities with the FCC. The bottom line is that Liberty has addressed the concerns that the FCC had with the initial application for de facto control. At this point the appeal to the FCC has been in front of the commission longer than the original application. If the FCC were rejecting this, as some theorize, on the lack of a Sirius XM signature, then the appeal would likely have already been denied. It is my opinion that the FCC is giving this appeal serious consideration. While we may see another rejection, we will also see permission for Liberty to gain de jure control. That is the key.
Liberty has the options and various paths it can take. Sirius XM can really only react to Liberty moves and even with that can only really cause delay. It is permission for control that is the key with the FCC.
Additional disclosure: I have no position in Live Nation.