Since their inception, much speculation has flown about surrounding Sirius XM's (SIRI) $1.875 exchangeable senior subordinated notes. With Liberty Media (LMCA) seeking, and likely soon to receive, control of Sirius XM, a clause may be triggered which allows these notes to be redeemed or converted to shares. This will have certain effects which should be understood by all Sirius XM investors.
First, take a look at this link here for a thorough explanation of the notes. For most, this will be a lot more data than they wish to get into, but if you have any questions they all should be answered in the document at that link.
The important parts investors need to know about are the following :
- $550 million in notes are outstanding. This is $550 million of Sirius XM's debt.
- Notes are convertible to shares at a rate of 533.33 per $1000 value.
- There is a change of control clause which allows early redemption of these shares. Early redemption provides bonus shares above the 533.33 (533 for example purposes) which varies based on share price at the time of change of control.
In effect, underlying the $550 million in bonds are approximately 293 million shares at a price of $1.875. At expiration or change of control it can be expected that if the share price of Sirius XM is above $1.875, that these bonds will be paid to holders in shares of Sirius XM, and if the share price is under $1.875 these bonds will be paid to holders in cash. Given that the share price is currently $2.59, far above the $1.875 mark, it can be assumed that the bonds will be paid in shares, and not in cash.
With that assumption in place, there will be an issuance of new shares on a change of control at Sirius XM. How many shares? Another assumption must be made. Refer again to the document linked above. On page 78 of this document there is a very large table listing "bonus shares" to be paid for early redemption due to certain events of which "change of control" is one. To keep things simple, we will assume the change of control happens on 12/1/2012 at my 2012 year end target of $3 per share for Sirius XM. Looking at the table you will notice that additional shares awarded come in just shy of 44 shares for this date and share price.
Add this to 533, and you have ~577 shares per $1,000 bond value to be issued on change of control, or 317,350,000 new shares issued.
Now comes the important part. What effects will this have?
The first thing which needs to be considered to answer this question is Liberty Media. Liberty Media, in order to maintain control of Sirius XM, will need to purchase 50% of these shares as their issuance dilutes its stake. My understanding is that Liberty does own $11 million worth of these bonds, which convert to 6,347,000 shares in this example, which reduces the amount of shares it must purchase. Of the 317,350,000, Liberty will have to purchase at least 152,328,000 shares. Because of this only 158,675,000 shares will enter the market.
But will these shares enter the market? It is assumed by many that over 200 million shares of Sirius XM's significant short position, has been shorted by the holders of these notes. Bond holders likely bought the notes, shorted the stock against a portion (typically assumed to be over 66%) the underlying shares to get their cash back, and have collected 7% for $0 cost. This gives them a covered position. When one makes this assumption, 200 million shares must be covered when these bonds are redeemed, yet only 158.675 million shares are left after Liberty's purchases. What does this mean? Liberty's purchases cover the deficit of 41.325 million shares from the outstanding float.
Despite new shares being issued, and despite this effectively diluting the stock, over 41 million shares of Sirius XM will need to be purchased from the open market to cover short positions and to keep Liberty in a controlling position over 50%. Will this move Sirius XM's share price significantly? That remains to be seen, but 40 million shares of purchasing in short order may very well provide a pop when this happens.
There's another effect of this conversion that bears mentioning. When these bonds are paid out in shares, $550 million worth of Sirius XM's debt is removed from the books, and future interest payments, $77 million worth, are saved. In one fell swoop Sirius XM will save $77 million going forward *and* have an additional $550 million in borrowing power. This will provide for the capability to add $550 million to a share buyback plan going forward, which is what many expect Liberty Media to do as its first order of business upon obtaining control. If one assumes a buyback at $3 per share, this will allow for an additional 183.33 million shares to be repurchased from the float.
In summary, what can investors expect on change of control, assuming this happens on 12/1/2012 at $3 per share?
- Issuance of 317,350,000 new shares
- Liberty Media purchases of 152,328,000 of these shares
- 158,675,000 shares entering the market
- 200 million shares short to be covered
- 41,375,000 shares must be purchased to make up the difference
- Reduction of $550 million of Sirius XM debt
- Savings of $77 million worth of interest for Sirius XM
I have made a considerable number of assumptions in this article which may or may not play out, but this should give investors a good starting point to use your own numbers for your own approximations.
One thing is certain. Liberty Media's pursuit of control will significantly dampen the potentially negative impact of the newly printed shares coming from these bonds. This is regardless of your assumptions of the date on which it happens, and the share price at the time. That's good news for investors who may have been worried about the redemption of these in the future. Depending on your viewpoint, the conversion of these bonds can now be seen as a rather positive event.
Disclosure: I am long SIRI.