In 2009, billionaire John Malone and his Liberty Media Corporation (LMCA) negotiated a sweetheart deal in hopes to save Sirius XM (SIRI) from inevitable bankruptcy. At the time, Mel Karmazin, Sirius CEO, was warding off anxious creditors at the same time that his stock traded for pennies on the dollar. Liberty Media Corporation extended an eleventh-hour $530 million loan in exchange for preferred stock convertible into 40% of Sirius stock. Today, Sirius XM trades for $2.50, which calculates out to $9.8 billion in market capitalization. After converting preferred stock and purchasing shares on the open market, Liberty Media now owns slightly less than 50% of Sirius XM Radio. As an already impressive score, John Malone and Company's original $530 million Sirius investment is now worth $4 billion.
Rather than cashing out, John Malone continues to lobby the Federal Communications Commission (FCC) for permission to up the ante and purchase more than 50% of Sirius. With FCC approval, Liberty Media would then be free and clear to establish legal, or de jure, control over Sirius. Without the green light, Malone still calls the shots as Sirius XM Radio's most powerful shareholder. At present, the legal and financial wrangling is but a mere sideshow. Sirius XM Radio cannot be salvaged.
Mel Karmazin vs. John Malone Feud
Today, Mel Karmazin, 69, and John Malone, 71, are keeping Sirius together with emergency duct tape and smoke and mirrors financing. As media titans, Malone bankrolls the operation, while Mel Karmazin is the rainmaking dealmaker pounding the pavement to close deals with BMW, Ford, Eminem, and Howard Stern. Rather than a full embrace of this symbiotic relationship, Mel Karmazin and John Malone have grown dismissive of each other amid this rescue mission and power struggle.
According to Jeff Bercovici and Forbes Magazine, the Karmazin - Malone relationship has effectively degenerated into a war of ideologies. To date, Mel Karmazin's operating strategy leverages existing satellite infrastructure and high-profile media connections to mine cash flow. Alternatively, John Malone is a well-heeled wild card offering contradictory statements to the press. Last July in Sun Valley, Idaho, Malone declared that he plans to invest capital into Internet systems that would help Sirius XM compete with the likes of Pandora (P). Prior to this announcement, John Malone behaved as if he wished to merge Sirius with Liberty Media, only to slash costs and spin off the satellite radio company for a relatively quick profit through financial engineering.
Greg Maffei, Liberty Media CEO, intimates that the "historically expensive" Mel Karmazin will be shown the door immediately after a Liberty - Sirius acquisition closes. Says Maffei, "the graves are full of irreplaceable people." The double-dealing is similar to a poker player who refuses to show his hand. Certainly, it would serve Malone's interests best to effectively hijack Sirius shareholders and talk them down, in order to avoid paying a premium. To do so, Malone must present himself as a long-term operator who sincerely hopes to integrate Liberty Media and Sirius Radio content through various transmission channels. Without the personal touch of Karmazin, however, Sirius cannot continue its turnaround as a growth story in a struggling industry that prioritizes handshake relationships.
As a Catch-22, John Malone's recent transactions have effectively established a put on Sirius stock. Ironically, Sirius may already be overvalued, largely due to Malone's own aggressive buying. Behind the scenes, Sirius insiders are abandoning ship. Beginning on April 15, 2012, a Yahoo Finance report shows Karmazin exercising Sirius options at 43 cents per share, and immediately selling stock for millions of dollars in profit every transaction. Mel Karmazin is not on board with the current Sirius program, as he continues to dump his position into the hands of John Malone.
Big Media is Failing
According to Gallup, American distrust in Big Media is at an all-time high. The results of a survey conducted between September 6 and September 9 indicate that 60% of all Americans have little to no trust in mass media to report the news fully, accurately, and fairly. Gallup defines mass media as television, newspaper and radio. This report analyzes media distrust among party lines prior to election season. Only 26% and 31% of all Republican and Independent voters, respectively, are willing to express a great deal of trust in mass media.
For Liberty Media and Sirius Radio, these statistics highlight an ominous trend in American interpretation of news. Today, the inmates literally run the Web 2.0 asylum. The spectacular nominal growth of infinite anonymous message boards, alongside Facebook (FB), Twitter, Google (GOOG) - YouTube, and The Huffington Post, prove that Americans are more comfortable making news than they are receiving news. Behind Web 2.0 infrastructure, talented citizen journalists can either hawk content in a meritocracy, where traffic correlates to payments, or the do-it-yourselfer can give away ideas for free to generate online buzz. Compared to Big Media, the Web 2.0 space is The Wild West of unfiltered information. Today, grandfatherly Walter Cronkite and shock jock Howard Stern are already relics of the past.
The Web 2.0 business model is also re-engineering the music business and destroying satellite radio. Together, Apple (AAPL), Microsoft (MSFT), Google, and Pandora have all created a streamlined ecosystem for sharing digital music files. Ironically, the iPhone has emerged as the centerpiece of this movement. As an entertainment center, the iPhone features iTunes downloads and Pandora streaming radio applications. Users can then dock the Apple iPhone to headphones, stereo speakers, and automotive dashboards to customize and amplify digital music. During its latest third fiscal quarterly period ended June 30, Apple sold 26 million iPhone units. Taken together, the iPhone, iPad, and iTunes accounted for $19.4 billion of Apple's $35 billion in total Q3 2012 net sales.
Apple's financial performance, in concert with the popularity of Web 2.0 social media, work to spell doom for Sirius XM's operations. Headline act Howard Stern is a saint, in comparison to readily available online debauchery. In 2006, Howard Stern signed a blockbuster five year, $500 million contract in cash and stock with Sirius that introduced satellite radio to the American lexicon. Despite putting Sirius "on the map," Howard Stern's tenure in satellite radio also includes star-crossed contractual disputes and run-ins with traditionalist Mel Karmazin. In 2011, after threatening to take his show on the road, Stern relented and signed a contract to remain at Sirius into the near future.
Hapless investors will be "Waiting for Godot," if they believe that an egomaniacal motley crew of John Malone, Mel Karmazin, and Howard Stern are to negotiate a consensus pact for long-term Sirius XM growth. In a Wall Street Journal interview, John Malone declares, "Control is control is control is control. My whole life has been about control."
The Bottom Line
Last year, Sirius XM Radio turned a $427 million profit. For shareholders, this performance is cause for celebration, considering the fact that Sirius generated $544 million in 2011 operating cash flow, after posting a relatively staggering $5.3 billion loss in 2008. Sirius' intermediate term recovery is largely due in part to Detroit bailouts and easy financing terms that have supported improved automotive and satellite radio subscription sales. The stock market, of course, is a pricing mechanism that discounts future growth. Going forward, European contagion alongside increased market penetration for digital media will destroy Sirius' profitability. As a betting man, John Malone should take his chips off the table, cash out, and run.
Instead, Malone will forge ahead to his very own Waterloo. The proposed Liberty Media - Sirius XM Radio merger is eerily reminiscent of late nineties wheeling and dealing. At the time, Jack Welch was angling to take over Honeywell, as the Final Act of his legendary management career. Wall Street was then the euphoric Promised Land of cheap money, revolutionary technologies, and grandiose egos to match legendary reputations. In 2001, the General Electric - Honeywell proposal was to collapse amid the dot-com bust and European Union rejection. Unscathed, Jack Welch was then free to ride off into the sunset.
Likewise, John Malone cannot save Sirius Radio from today's prevailing regulatory, technical, cultural, and economic headwinds on reputation alone. Going forward, Sirius XM and Liberty Media shareholders are setting themselves up for severe losses, largely due in part to the clash of personalities between a few legendary figures, who now happen to be out of their league.
Disclosure: I am long AAPL.