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Seeking Alpha user 'PRMK' posed an excellent question to me earlier today within the comments section of my article here. In essence their question was as follows :

Why do you think Sirius XM (NASDAQ:SIRI) will refinance the $400 million worth of bonds when it is obvious it has enough money to just pay them off like the $186 million in bonds they are due to pay off in September?

I simplistically replied that 5.25% was a much better rate, and PRMK questioned again :

Yes, a 5.25% rate is better but not having the debt at all, I feel, is better. Since they have almost a billion by years end to reduce the debt why acquire more at this point? Too much cash sitting around has not proven to be wise.

I feel this question may be on a lot of people's minds and I'd like to take a moment to explain some of the logic behind Sirius XM refinancing vs. paying off with the cash they already have.

One thing which must be considered is that they are already looking to pay off part of this chunk of debt, $681 million, with cash on the balance sheet. Sirius XM is not seeking to pay off only $400 million of that debt. They're looking to retire part of it with cash ($281 million) and part of it with a refinance ($400 million). Spencer Osborne at siriusbuzz.com has a nice article up that covers some of the cash benefits of the refinance here.

Returning to the question, why refinance and not just pay off the entire amount with cash? Because given the 5.25% rate Sirius XM can currently borrow the $400 million at, the cash is better served elsewhere. One example would be using these funds for stock buybacks. Liberty Media (NASDAQ:LMCA) has already made note that they will likely leverage Sirius XM's balance sheet up after a reverse Morris trust in order to fund a large scale share buyback plan and reduce the float of Sirius XM.

Using an example some may better understand, let's say I have $400 in cash in my pocket. I have a $400 loan available to me at 5.25% and I have the ability to purchase something (in Sirius XM's case, its own stock) which is expected to appreciate at an imaginary rate of 20% per year. I also have $400 worth of debt which currently costs me 13% per year.

I have options in this scenario, but they both work to the same end.

Consider :

  1. I can refinance my 13% loan at a lower 5.25% rate and use the cash in my pocket to buy my stock. Result? Interest savings of 7.75% per year on $400, and 20% appreciation on my $400 stock buy back. 27.75% per year (roughly) gain over my previous position.
  2. I can pay off my current 13% loan with cash, and take a 5.25% loan to purchase my own stock. Result? 13% savings on the old loan, and 14.75% appreciation (20% rate minus 5.25% loan rate) on the stock. 27.75% per year (roughly) gain over my previous position.

As you can see, when playing with numbers, and in this case money, so long as both sides of the equation balance out the end result is the same. Taking a loan for $400 million to pay off a old debt and using $400 million cash for stock buybacks has the very same result as using $400 million cash to pay off the old loan and taking a new loan for $400 million to buy back stock.

What's less important is how Sirius XM is doing this, and what is more important is what is being done. The end result here is interest savings, stock buybacks, and what should be a subsequent appreciation in the share price of Sirius XM. The better the rates that Sirius XM is able to get, and the more comfortable it is with leverage, the greater the upside potential to Sirius XM's stock price that exists. Sirius XM is not setting up to buy back large amounts of the company's stock "just because." It is doing so because it expects the appreciation of the stock to increase at a rate much greater than the interest rates it will pay in order to leverage the buyback. This is a money making move by Sirius XM, and investors will be rewarded handsomely for it.

The confirmation and realization of this is one of the biggest factors driving the increase in share price right now. While the current uptrend may pull back from time to time on profit taking, I fully expect share price appreciation to continue.

Source: Why Sirius XM Would Refinance $400 Million Vs. Paying Off With Cash