In the past few weeks Sirius XM Radio (SIRI) has had several press releases about its debt. It has announced that it issued $400 million of new 10 year debt at 5.25%, plans to call $186 million of 9.75% debt and plans to call $681 million of 13% debt. All of these transactions have occurred, or are scheduled to occur, during the third quarter.
I expect that these transactions will result in incremental expenses and cash usage of nearly $100 million for the third quarter. This will be from a combination of new interest expense on the $400 million of 5.25% debt and the call premiums (a charge for the early extinguishing of debt) on the two high interest issues. These transactions will reduce GAAP EPS. The new debt will offset a portion of the nearly $1 billion of cash used in the debt retirement and incremental interest expense.
Liberty Seeks Control of Sirius XM and S&P Reaction
While all this was taking place, Liberty Media (LMCA) disclosed that it would be seeking consent from the FCC to go to de jure control of Sirius XM, increasing its stake from 48% to over 50%. Standard & Poor's had the following reaction:
There is significant uncertainty in relation to the financial policy that Liberty would pursue if it controls the board of Sirius XM.
...Without potential debt-financed share repurchases, we believe continued improvement in profitability will result in a further reduction in gross debt leverage to roughly 2.75x by year-end 2012, which we view as one element of an upgrade scenario to 'BB+'.
S&P went on to state that a near term upgrade would be unlikely until Liberty's financial strategies were better understood. In fact, although "not currently expected" S&P could possibly lower the Sirius XM rating to BB- if it believes Liberty would significantly increase leverage to 5.5x. The 5.5x is double the 2.75x leverage stated above. (More on this later).
Liberty executives have been stating for some time that they thought Sirius XM was under-leveraged and that the company should "shrink" the share count. And, earlier this month Liberty Chairman John Malone said:
"Our view is that Sirius is under-leveraged and there's plenty of opportunity for share repurchase and other financial actions at the company, which we deem is ultimately positive..."
It is likely that the above statements contributed to the S&P uncertainty and its concerns of increased leverage.
There is another valid reason for S&P to be concerned about the amount of debt Sirius XM may take on besides the recent comment by Malone. During the Q&A portion of Liberty's second quarter conference call, CEO Greg Maffei stated, ""We would like to get the basis [?] back on the 11 points." If this means that Liberty wants to get back the cash it has spent so far, as well as the additional sums it will need to go to de jure control, Sirius XM will need to come up with a lot of cash. I expect that the total expenditures by Liberty would be between $1.3 and $1.5 billion.
Adding to uncertainty are comments about the possibility of Liberty executing a Reverse Morris Trust ("RMT"). To execute the RMT, Liberty shareholders must own a majority of Sirius XM. But if Sirius XM buys back the Liberty 11%, the Liberty shareholders are no longer majority owners. One way around this, while at the same time buying back the Liberty stake, would require that Sirius XM also purchase 11% on the open market.
While such purchases would greatly reduce the share count, Sirius XM would be saddled with a great deal of debt. Note that S&P was concerned about a Gross Debt to EBITDA leverage climbing to 5.5x. It would appear that $$2.6 - $3 billion of new debt (to fund the purchases of 22% of the company), in addition to an expected debt level of about $2.4 billion following the three debt transactions noted at the top of this article, would bring the total debt to $5.0 - $5.4 billion. With EBITDA guidance at $900 million, the leverage would be 5.6x - 6x, above the S&P level that could trigger a downgrade.
A Sirius XM share buyback is a double edged sword. It lowers the sharecount, reducing the denominator in an EPS calculation. It also requires, in this instance, that the company take on a significant amount of new debt along with significant incremental interest expense. This reduces the numerator in the EPS calculation. And, if ratings agencies lower the debt rating of Sirius XM, the new debt will carry interest rates greater than the recent 5.25%.
Some Sirius XM investors were expecting to get clarity following the announcement by Liberty that it would be seeking FCC consent to go to de jure control. S&P now expects uncertainty, largely caused by Liberty's potential plans on leveraging up for a share buyback.
Investors expecting an upgrade in the company's debt ratings are likely to be disappointed in the near term, at least as far as an S&P upgrade is concerned.
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 may initiate (or close) a buy stock/sell option position in Sirius, at any time. 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.