The beginning of August has been crazy, with shares of Sirius XM (SIRI) trading at a low of $2.09 on Aug. 1 to a high of $2.51 and closing at $2.48 on Aug. 8. Sirius XM bulls, like myself, are having a great time watching the share price skyrocket. I wanted to write this article in order to recap the reasons I believe the share price has surged so much since Aug. 1 and to discuss what was talked about between Sirius XM's Q2 conference call, Liberty Media's (LMCA) Q2 conference call, and Liberty's annual shareholders meeting.
The initial run-up in Sirius XM shares from Aug. 1-6 from $2.09-$2.23 was mostly likely due to the speculation that Sirius XM would report better-than-expected earnings for Q2. As we all know, that is exactly what happened:
Sirius XM Radio announced second quarter 2012 financial and operating results, including revenue of $838 million, up 13% over second quarter 2011 revenue of $744 million. Net income for the second quarter 2012 and 2011 was $3.1 billion and $173 million, respectively. Adjusted EBITDA for the second quarter of 2012 was $237 million, up 28% from $185 million in the second quarter of 2011.
The net income gain was due to a one-time tax benefit, where Sirius XM recognized $3 billion of its NOLs this quarter.
On Aug. 7, shares surged to close at $2.30. This was due to the results posted for Q2 before the market opened on Aug. 7. I'd like to point out two facts from the conference call that are often mentioned, but not always fully recognized:
- Two-thirds of all new cars sold today come equipped with a Sirius XM radio. This is really pretty incredible and puts up strong barriers to entry.
- 35%-50% of all customers now pay the full price hike price. This is also great because churn has not budged from 1.9%.
I was not sure the stock would hold at $2.30, but the real news came out on Aug. 8 with Liberty Media's Q2 results, conference call, and annual shareholder meeting. Shares of Sirius XM surged again to close at $2.47.
I will first point out the key items that were stated, and then combine them to show why I think (and clearly the market thinks) Aug. 8 was a very epic day.
1. Greg Maffei, president and CEO of Liberty, announced the company's plan to spin off Starz LLC from Liberty Media to create a new company:
We are pleased to announce our plan to separate the assets of Liberty Media and Starz, LLC, creating two separate asset-backed stocks. This transaction will provide better transparency on the Starz operating business; optimize the Starz capital structure; permit us to better pursue our strategic objectives, including creating two currencies that could be used for acquisitions; and create significant liquidity at Liberty Media, which preserves all our options with respect to SiriusXM and Live Nation.
2. Liberty Media physically settled the forward purchase contracts of Sirius XM, and it now owns 46%.
3. Maffei said the following during the Q2 conference call:
RMT in the short term is probably not as attractive for us -- meaning not in the next six months -- or something like that because we are more interested in seeing them re-lever and get the appropriate valuation at Sirius, we think the valuation at Sirius is likely to go up upon re-levering or further levering of the company and we probably want to participate in that. Also we would probably -- as noted -- would want to get some of that capital off the table… We'd have to get to 51% anyways… This is all stuff -- in terms of share repurchase -- that is in the main... working toward an RMT if that is the route we chose.
4. Sirius XM's leverage is 3.6 times adjusted EBITDA and closer to 2 times when you take into account the amount of the company has. (Liberty feels Sirius XM can handle a much higher leverage rate.)
5. Sirius XM is looking to clean up its balance sheet, offering $400 million of notes due in 2022. It will likely use the money to pay off existing debt when callable in the next few months.
All of this data combined is what led to a surge of 7.61% on Aug. 8. The reason for this is because the data and statements show that Liberty has a strong intention to gain 51% of the company, regardless of whether it gains de facto control or not.
Liberty plans to spin off its Starz LLC stake, which helps "preserve our options with respect to Sirius XM and Live Nation." This gives the company a "currency" with which to pursue its plans. In my opinion, this clearly means it plans to up its stake in Sirius XM to 51%. This would be done by either Liberty buying up the remaining 5%, Sirius XM buying up remaining 5%, or Sirius XM paying some kind of dividend to the shareholders. That solidifies that there will be 5% less float in the coming months before Liberty will be able to make further moves forward. Once Liberty gains the 51% control, it will then move down one of several paths. In my opinion, the mostly likely option would be the Reverse Morris Trust that it also performed on Discovery Communications (DISCA), Direct TV (DTV), and now the soon-to-be public company Starz LLC. However, I only want to mention what may happen in between now and then.
Maffei stated that "the valuation at Sirius XM is likely to go up upon relevering or further levering of the company, and we probably want to participate in that." It thinks the capital structure could and should be restructured to add value to the company. It would perform this upon gaining the 51% stake. It would then want to monetize its stake in Sirius XM. This could be done by using the Sirius XM leverage to buy back the shares from Liberty Media that were bought to gain the 51% stake. In either case, the shares would be Liberty's or Sirius XM's, and the shareholders would benefit.
The restructuring is important because currently Sirius XM does not want to initiate a share buyback. That's because that would make it easier for Liberty to gain the 51%, but if Liberty gains control it will want to use Sirius XM's current cash and available further leverage to return value to the shareholders (i.e., share buyback or dividend). Liberty is known for share buybacks, and I don't think this would be any different if and when it gains control of Sirius.
I am still skeptical as to what will happen after the RMT, but I don't think this will be an issue for the next six months, as Maffei said during the conference call mentioned above. I think we will be along for a nice ride. In summary, I think we are going to see Liberty move to gain 51% of Sirius XM, restructure Sirius XM to further leverage the company, and use the cash to return value to shareholders while monetizing its position. This will all be done while Sirius XM continues to add subs, generate tons of cash, and clean up its own balance sheet.
It has been an exciting month for Sirius XM and I think there will be much more to come. However, if you are concerned (like myself) of the stock retreating, I would consider selling some protective puts to protect your position over the next few weeks. You may also consider selling a portion of your gains in order to lock in some of that.
Disclosure: I am long SIRI.