As Sirius XM (SIRI) gets ready to report its Q3 2012 results, there are many things the street would like to tune into. Of course, investors are looking for good numbers, but that is almost secondary to the real meat and potatoes that the street wants to hear. What the street is clamoring for is 2013 guidance and an announcement regarding share buybacks. In many ways, these announcements need to come hand-in-hand. Here is why.
Current Sirius XM management has made no secret that it feels the proper debt to EBITDA ratio is 3-to-1. What that means is that the level of debt should be 3 times the EBITDA guidance. By example, Sirius XM's 2012 EBITDA guidance is $900 million. A 3-to-1 ratio would mean that the sweet spot for debt is $2.7 billion. Currently the company sits at $2.45 billion. Essentially the company is "under-levered" at this point.
It is also no secret that Liberty Media (LMCA) management, the company poised to take a controlling interest in Sirius XM feels that the company is "under-levered", and even expressed that feeling when Sirius XM was at a ratio of 3.5-to-1. What that means is that the company taking over Sirius XM feels that the company can handle more debt. Whether that is 4-to-1 or 4.5-to-1 can be the subject of debate, but for the purpose of this article I will use 4-to-1.
This is where the 2013 guidance being issued is so important. As stated above, current EBITDA guidance is $900 million. If the company were to announce more debt tomorrow, and take the ratio to 4-to-1, they would be announcing an additional $1.15 billion in debt. In contrast, if the company were to issue 2013 EBITDA guidance of $1.15 billion, it could take on about $2 billion in debt and maintain a 4-to-1 ratio. By getting new guidance out onto the street, the company can gain more latitude and flexibility with how much it may borrow.
There are a few things to note here. While the company eliminating shares from the float via a buyback is important, even a lofty number like $3 billion will not carry a massive impact, and will need to happen over a period of many months. If the average stock price is $3.00, the company would be able to remove 1 billion shares. A higher stock price means fewer shares.
Liberty Media has stated that the process of control, and what it will ultimately do with its Sirius XM stake could take a couple of years. The main reason for this is that it is a stated goal from Liberty that it would like to get back some $1.5 billion it invested into about 700 million shares of SIRI common stock. Unwinding that position will take time, and will likely be accomplished by additional debt, and use of cash. It is also a dance of sorts, with Liberty Media needing to sell back some of its shares at a matched pace with common holders in order to maintain an ownership level over 50%. Currently Liberty ownership sits at about 49.5%.
Essentially the buyback program will start as soon as Q4 2012 and continue for several months as the company strategically buys shares at opportune times. Let's not forget that the goal of a share buyback program is to buy back as many shares as possible for the most reasonable price.
The great news about this is that unlike in the past, when the equity starts to stumble, there is a safety net in Sirius XM buying shares. This offers stability to the equity that simply did not exist before. Think about that for a moment. In the past when Sirius XM would run up, it would become a natural point for stock sales, and even short traders to hop into the market. If Sirius XM is standing there ready, willing, and able to buy up shares, it will effectively limit any substantial move to the down-side. The share buyback, when announced, offers longs some stability and protection.
The key for savvy traders is this. The Q3 earnings call is not about EPS. In fact, the EPS will likely simply meet street expectations at 2 cents per share. The important factors of this call will be the guidance and an anticipated share buyback. Even the employment status of CEO Mel Karmazin is trumped by the guidance and buyback issue. This news, if delivered, can have an immediate impact on the share price. It will be viewed as positive even if coupled with some debt to accomplish it.
The key for investors is to be prepared for that now and to remember that it is share buybacks that are the main fuel for some aggressive analyst upgrades and higher price targets.