The formerly even Sirius XM Radio (SIRI) debate has now been hijacked and degraded into a one-sided affair led by rabid bulls. Sirius cheerleaders do not tolerate dissent. At the top, conspiracy theorists haughtily shun the sell side as white flag machinations of hedge fund players on the wrong side of this trade. At $2.70, Sirius shares have more than doubled off their $1.27 52-week low.
Sirius shareholders take heed. A perpetually looming Liberty Media (LMCA) deal, cult of personalities, and cheap money can easily combine to finance a speculative bubble. At these levels, potential risks far outweigh prospective rewards. Sirius XM Radio is not an ideal long-term investment, due to the tectonic shifts now taking place within Big Media and Silicon Valley. Rather, Sirius is ripe for immediate financial engineering, at the expense of long-term owners.
Cult of Personalities
In early 2009, Mel Karmazin, Sirius CEO, was lording over a declining empire, where bankruptcy appeared inevitable. Between Q1 2001 and Q1 2009, Sirius XM Radio shares collapsed from $61 to a lowly twelve cents on the dollar. At this nadir, Sirius was coming off a $5.31 billion 2008 loss that manifested itself further as a staggering debt load of $7.5 billion in liabilities against $7.5 billion in assets. At the eleventh hour, John Malone and Liberty Media answered the call and negotiated a sweetheart deal to save Sirius. Liberty Media would extend a $530 million loan to Sirius, in exchange for preferred stock convertible into 40% of common stock outstanding.
Today, Sirius trades for $2.70 and carries 3.8 billion basic common shares outstanding on its balance sheet. Sirius investors are exposed to extreme dilution, in the form of preferred stock and option conversions that could take the common stock outstanding total to a bloated 6.5 billion. Shareholders are therefore at the mercy of financial managers, who must take care to enter the open market and buy back stock, in order to cancel out dilution from fresh shares hitting the market. For Sirius, Bloomberg estimates $14.1 billion in market capitalization on 5.2 billion shares outstanding. According to these calculations, Sirius trades for 31 times trailing 2011 earnings.
After preferred stock conversions and open market purchases, John Malone and Liberty Media now own 49.7% of Sirius Radio. Malone has already struck gold on his original $530 million investment, which is now worth roughly $5.4 billion. As the representative of Sirius' largest shareholder, John Malone operates with de facto control. For de jure, or legal control, Malone is lobbying the Federal Communications Commission for the second time to increase his Sirius stake above 50%.
The Liberty Media - Sirius wheeling and dealing foreshadows the ultimate clash in John Malone, Mel Karmazin, and Howard Stern personality cults. The Wall Street Journal describes the simmering Malone -- Karmazin feud as a time-oriented battle of ideologies. Apparently, Karmazin prefers to mine Sirius' existing infrastructure for immediate cash flow, while Malone is anxious to invest capital into long-term projects that can compete alongside the likes of Pandora.
At center, Howard Stern and his original 5-year, $500 million contract is the headline act of Sirius content. A Web 2.0 business model that includes Facebook (FB), Google (GOOG) - YouTube, Twitter, Pandora (P), and Apple (AAPL) will increasingly challenge Stern's salary and profession as an over the top shock jock. A recent Gallup poll reveals that distrust in American media is now at an all-time high. Going forward, this trend will embolden a fresh crop of raw Web 2.0 citizen journalists, while also eating away at Sirius' subscriber rolls, listening time, and advertising revenue. In this environment, tectonic shifts in strategy are necessary for Sirius' mere survival as a going concern.
Greg Maffei, Liberty Media CEO, already intimates that a changing of the guard is taking place at Sirius. Maffei dismisses the self-anointed "historically expensive" Mel Karmazin, with claims that "graves are full of irreplaceable people." In 2009, Mel Karmazin took down $43.5 million in executive compensation. This year, a Yahoo Finance report reveals that Karmazin has been quick to exercise options at 43 cents per share and immediately sell off stock on the open market -- for millions of dollars in profits. Sirius cheerleaders, of course, will argue that Karmazin, 69, is simply diversifying his portfolio before being shown the door and riding off into the sunset.
Sirius is a Target for Financial Engineering
Sirius shareholders are in jeopardy of signing on for John Malone's gamesmanship, only to be left holding a toxic bag of assets after the smoke clears. Zero interest rates, a third round of quantitative easing, alongside Malone's telegraphed and aggressive purchases effectively install a built-in put within Sirius shares. For its latest second quarterly period ended June 30, Sirius reports $3.1 billion in quarterly net income on only $838 million in revenue. Sirius' bottom line figure includes $3 billion worth of tax credits. The Q2 2012 balance sheet itemizes $9.5 billion in assets over top of $5.5 billion in total liabilities.
Without the $2.1 billion in tax carry-forwards and $1.8 billion in brand name goodwill, Sirius offers $100 million in shareholder equity and is capable of generating $500 million in pre-tax benefit annual profits, at best. Fundamentally, Sirius is not a worthy long-term investment at $2.60, or $13.6 billion in market capitalization.
John Malone is not likely to buy out Sirius shareholders at a significant premium. If anything, Malone will present himself as a long-term holder, in order to stabilize the price tag of his looming acquisition. With the help of ingenious financial engineering, John Malone can set up a Reverse Morris Trust to acquire Sirius and spin it off to Liberty Media shareholders, in a tax-free transaction. This Reverse Morris Trust would call for Liberty to combine Sirius with another entity, such as its 16% stake within the Mobile Streams content portal. This separate and larger satellite radio operation would maintain its own management team, but still remain effectively controlled by Liberty.
John Malone is a shrewd businessman who now operates from the catbird seat. Liberty Media has already thrown its weight behind Sirius to refinance debt and restructure bond agreements to accommodate a Reverse Morris Trust scenario. Once the spinoff is complete, satellite radio managers will immediately slash costs in order to improve the mirage of cash flow from operations, at the expense of real bottom line long-term growth.
Sirius has been riddled with debt throughout its history and Liberty is not likely to continue throwing good money after bad in an attempt to improve operational performance. As for Malone's feigned interest regarding Internet radio build-out, Pandora is the canary in the coalmine. Pandora is bleeding cash, as the growth in content acquisition costs historically outpaces increased advertising revenue. Ironically, Pandora's Internet radio business is a more expensive operation and financial loser, as it grows in popularity. Meanwhile, automakers are destined to include Internet radio consoles as standard equipment. This technology will inevitably force Sirius to follow Pandora's lead and dump product at a loss.
Media investors are now taking a gamble that they can cash out of Sirius at a profit, before Wall Street wises up to this game. Structural deficiencies embedded within this fused Satellite/Internet radio business model inhibit growth, while debt balloons. Sirius cheerleaders must recognize that the easy money has already been made, and begin taking profits.
Disclosure: I am long AAPL.