Several months ago when Liberty Media (LMCA) first disclosed that it had entered into a Forward Contract to acquire 302 million shares of Sirius XM Radio (SIRI) at $2.15 per share, there was a great deal of discussion about whether the $2.15 represented a floor or a ceiling price. Shortly after that announcement, Liberty filed a Form 4 with the SEC disclosing it had purchased an additional 60.35 million shares at less than $2.13/share. Then, last week, Liberty filed a Form 4 disclosing that it purchased nearly 90 million shares for an average price of just over $2.48 per share and had entered into a forward contract to purchase 41 million shares at less than $2.05. And, in its most recent 13-D, Liberty announced it bought another 4 million shares at just under $2.53/share and was seeking the consent of the Federal Communications Commission ("FCC") to go to de jure control of Sirius XM.
Clearly $2.15 was neither a floor nor a ceiling as far as Liberty was concerned. Can an investor in Sirius XM use any of the purchase prices paid by Liberty to determine a reasonable value for the stock? If one goes by the analyst pricing forecasts, the simple answer is no. Yesterday an article by Demian Russian notes that RBC Capital Markets analyst David Bank saw the stock as fully valued and reiterated a $2.00 price target. And an article on the Forbes web site notes that ISI Group analyst Vijay Jayant maintained a buy rating on Sirius XM and raised his price target to $3.
Liberty chairman John Malone and CEO Greg Maffei sit on the Sirius XM board. They have excellent visibility into the prospects of the company and some investors in Sirius XM feel that if Liberty is willing to pay as much as $2.52 per share, it must be worth at least that much to other investors. It's an appealing idea and it seems so logical, but does it stand up to scrutiny?
Insiders Buying and Selling
The Liberty executives are insiders that know the strategic direction of the company and many of the longer term issues the company must address. Many of these issues would be discussed at board meetings and the correct type of probing questions can reveal a lot. But there are a lot of other insiders. Are any of them buying stock?
Since February, about a half dozen other insiders (excluding the planned sales of CEO Mel Karmazin) at Sirius XM exercised options and sold shares at prices between $2.0912 and $2.26. They also have access to inside information and know a lot about the day to day operations of the company, and none of them were acquiring - or even holding - their options/shares. Should investors follow their lead?
One of the most successful investors of all time, Peter Lynch, wrote that insiders sell for many reasons, but only buy if they think the price will rise. So, it stands to reason that investors should not necessarily be concerned about the insider sales. But what about the one half billion shares that Liberty is acquiring at prices between $2.05 and $2.53?
The Value to Liberty
Liberty acquired a preferred share stake equivalent to 40% of Sirius XM more than three years ago in exchange for a half billion dollar loan and a payment of $12,500. Earlier this year Maffei discussed that investment:
We already have a lot of negative control at Sirius XM ... We have 40% of the board by charter, or by contract rather. We have blocking rights about their ability to issue stock, about their ability to purchase, er, issue debt, their ability to do any acquisitions. We have a lot of controls, negative controls around that company
At that time Liberty management had an investment in an asset that was expected to generate $700 million in Free Cash Flow in 2012 and perhaps more than $1 billion in 2013. They had these "negative controls" but had no rights to force Sirius XM management to take the company in a direction that Liberty management felt it should go. Suggestions and recommendations could be made, but that was all.
Liberty's preferred share investment at that time could have been converted into 2,586,976,761 common shares worth more than $5 billion, and it couldn't dictate how that investment should be managed. It couldn't even distribute that investment to its shareholders without incurring a large tax liability on the multi-billion dollar gain. How does one place a value on the incremental increase in ownership necessary to control and manage an investment of that magnitude?
The decision at Liberty was to spend more than $1 billion to get close to majority control and to then seek permission from the FCC to take majority, or de jure, control. Liberty's second forward contract was for up to 220 million shares. Its counterparty was only able to acquire 42 million shares at $2.05, and that drove Liberty into the open market to acquire another 94 million shares last week where it was forced to pay an average price of close to $2.50 per share.
Does that mean Liberty management places a current value of $2.50 per share for the company? Does it even place a current value of $2.20 per share - the average price for all the shares purchased this year - for the company? Many are likely to argue that it does and they will point to the closing price of $2.56 yesterday to support that argument.
The half billion shares acquired by Liberty so far this year and the additional 150 million shares needed to take control of the company have a special value to Liberty. Liberty will pay less than $1.5 billion dollars to take control of a cash balance at Sirius XM that stood at $0.9 billion at the end of the second quarter and could grow to more than $2 billion by the end of 2013 while paying down debt. I would argue that the ability to control the use of those funds would serve as a motivation for Liberty to pay a large premium.
Some investors may feel that Liberty management with its insider's perspective sees an opportunity to acquire shares at a discount to fair value, and therefore the shares must be worth more. I would suggest that Liberty sees value in taking control of its investment, and is willing to pay above what they perceive as fair value for the opportunity to take that control. Whether investors agree or disagree about what constitutes fair value, they should at least recognize that there are unique circumstances surrounding Liberty's investment in Sirius XM, an investment that at yesterday's closing price of $2.56 had a market value approaching $8 billion.
Disclosure: I am long SIRI.
Additional disclosure: I have $3 January 2013 covered calls against most of my Sirius position, as well as some $2 and $2.50 January 2013 covered calls. I have no positions, or any plans to open positions in the next 72 hours, in any of the other companies mentioned in this article.