As speculated when the company announced $400 in new debt at 5.25% interest for the purpose of retiring some of its high interest 13% notes, Sirius XM (SIRI) has announced that it intends to retire all of the notes by combining the $400 million in proceeds from the refinancing activity with about $281 million in cash.
This move is quite interesting in that it will carry an impact on valuations, as well as get the company below its desired debt to EBITDA ratio of 3 to 1. When the transaction is completed in September, Sirius XM will have $2.44 billion in debt remaining on the books with the next due date not happening until December of 2014.
Debt to EBITDA Ratio
Sirius XM has oft stated that its desire was to get the debt to EBITDA ratio down to 3 to 1. At various times there has been debate over whether the company was referring to NET debt or GROSS debt. In the slide presentation at the annual meeting Gross Debt was used, as was the case in the most recent conference call.
With this debt retired the debt to EBITDA ratio will be at 2.7 to 1, below the stated goal of CEO Mel Karmazin. I anticipate that the company will announce 2013 guidance in November, and that would lower the ratio even further. The current ratio is arrived at by dividing the debt by the EBITDA guidance. If Sirius XM announces EBITDA guidance of $1.1 billion for 2013, the ratio would drop to 2.2 to 1.
This is where things could get very interesting! As investors know, Liberty Media (LMCA) is in the process of trying to gain de jure control of Sirius XM. Liberty's John Malone and Greg Maffei have stated publicly that they feel Sirius XM is under levered. This essentially means that they feel the company can take on more debt. This contrast Sirius XM CEO Mel Karmazin who has stated that 3 to 1 is the appropriate ratio. As it happens, the two sides actually agree in principal that the company is now under levered. The caveat would be that Liberty had that opinion when Sirius XM was at about a 3.7 to 1 ratio.
If new EBITDA guidance is indeed $1.1 billion, it would imply that by Karmazin's standard the company could handle new debt totaling $3.3 billion, or about $850 more in debt(total of $3.3 billion) than it currently carries. Assuming Liberty feels 4 to 1 is the proper ration, that added debt (if it happened) would be an additional $2 billion in debt for a total of $4.4 billion. This is interesting because it may well take new debt to get the Liberty deal complete.
EV / EBITDA VALUATION
Every action carries a reaction. One of the ways that most people value a media company is by looking at the Enterprise Value (EV) to EBITDA ratio. Traditionally Sirius XM has traded at a premium. This concept is oft misunderstood. If typical media companies trade at a multiple of 10, then companies that trade below that level are trading at a discount, and companies trading above that level are trading at a premium.
A premium can be deserved by company performance. By example, if the company is growing EBITDA at 20% per year, it deserves to trade at a higher multiple. One issue with trading at a high multiple is that on a valuation basis, the premium is built into the cost of the equity. In other words, you may not get a bargain buying the equity.
When looking at Sirius XM and valuation there are a couple of things to consider. One is the multiple it trades at with current data and the other is what it could trade at with assumed data going forward. Assumed data presents risks, and this is part of why price targets may be conservative.
A good example of weighing risk would be David Bank from RBC Capital and his $2.00 price target. Bank uses a Discounted Free Cash Flow model with a WAAC at 9.75%. One of his big concerns is the royalty issue. That concern carries validity because the track record has been that the royalty rates increase. Whether you agree or disagree with his target is not the real issue. What is the issue is that he outlined his concerns, his model, and his valuation for consideration. The most bullish analyst, John Tinker, carries a price target of $3.35 with assumptions that the company will buy back 250 million shares this year and another 400 million next. Understanding how analysts get to their respective price targets is of paramount importance. However, not all investors get to read the reports. This is why it becomes important to build your own models.
In the models above I have outlined the current state of Sirius XM and a 2013 model. As you can see, the multiple (excluding NOL's) is identical at about 20.4. The difference is the current model uses the current $2.56 price of SIRI, while the model for next year carries a price of $3.38. The change happens because of debt level, EBITDA guidance, cash, and share count. I am assuming a 250 million share buyback in my 2013 model.
The twist is that SIRI tends to be at the high end of the multiple spectrum when it gets above 20. We are there right now. The low end is about 15. We are likely only a few months away from new guidance which will help turn projected numbers into numbers that are much more real. I assumed in the 2013 model that EBITDA guidance would be at $1.1 billion. What if it is $1.2 billion? What if it is $1 billion? These are the types of unknowns that we speculate on today as we evaluate whether Sirius XM is a Buy, hold, or sell.
Bull vs. Bear
I oft see labels being attached to various writers and analysts. This writer is a bear, and this one is a bull, or my favorite, this one is a "closet bear". Would you not agree that it is easier to be bullish when SIRI is trading at a multiple of 15 rather than when it is at a multiple of 20? Just because I might identify 20 as being at the top end of the multiple range does not mean that I am bearish on the company and its outlook. It simply means that the premium that Sirius XM deserves is pretty well baked in at that level.
It is easy to pull out the pom poms and cheer bullish outlooks. It is much more difficult to pull out the magnifying glass and see the flaws. It is easy to write that the sub number is 622,000,000, it is much more difficult to analyze that the promotional category was up by 50% from the previous quarter and comprehend that 55% of those will deactivate at the end of the trial period.
As an investor perhaps it is best to avoid the bull vs. bear debate altogether and simply take in what is being said and why. Personally I understand the prospects of Sirius XM quite well. It is why I look for the things that might impact those prospects, both positive and negative. It is a balance we seek instead of a bull vs. bear label.