S&P Neutral On Karmazin Issue - Why This Is Big News

| About: Sirius XM (SIRI)

Well, it did not take long for Standard & Poor's to weigh in on the departure of Sirius XM (NASDAQ:SIRI) CEO Mel Karmazin as it relates to the company's credit rating. S&P rated the issue as neutral and noted several factors that they expect in the coming months.

While there is a level of uncertainty surrounding Sirius XM and how the company will be managed, it appears clear that one of the street's biggest credit rating services sees strength in the company operations and even states that Sirius XM can adequately handle more debt without changing the rating.

The good news in this is not that the S&P is neutral, but rather that it has anticipated possible moves by Liberty Media (LMCA) and sees the company as able to handle those moves. In many ways this neutral report by Standard & Poor's is a bullish one.

Standard & Poor's Ratings Services said today that its rating and outlook on Sirius XM Radio Inc. (BB/Stable/--) is not currently affected by the announcement that the company's CEO will depart on Feb. 1, 2013. Liberty Media Corp. plans to increase its stake in Sirius XM to more than 50% from 49.5%, gaining a controlling position, subject to Federal Communications Commission approval. We believe Liberty could pursue a more aggressive financial policy if it controls the board of Sirius XM. We anticipate that as a result, debt leverage could increase over the near term, and could also increase if Liberty Media's ownership input leads to debt-financed dividends, acquisitions, and/or share repurchases. However, at this time we do not believe leverage will increase above our 4.5x target for the current rating.

Essentially, the current credit rating has possible Liberty Media actions built in. While that means no credit upgrade is on the table, it also means that S&P is very unlikely to downgrade the credit either. Good news.

This announcement may be much bigger than most investors will realize at first blush. It is no secret that Liberty Media has stated that it feels Sirius XM is under levered (can handle more debt). It is also no secret that Liberty Media would like to get back about $1.5 billion that it invested to get to what is essentially a controlling stake in Sirius XM. The popular consensus is that Liberty Media will get back its money via a share buyback or a dividend.

While Sirius XM generates a lot of cash, it does not generate enough or have enough on hand to initiate the scope of buybacks or dividends that would be required to allow Liberty Media to extract that $1.5 billion. To avoid any issues, the cash needed to allow Liberty to get back $1.5 billion is about $3 billion. Essentially Liberty would only participate in half of either type of transaction.

To accomplish either a buyback or dividend in a shorter amount of time, Sirius XM would need to borrow money. Now do you see why this announcement by S&P is so substantial? Standard & Poor's has essentially stated that Sirius XM can go to 4.5x EBITDA with debt and the rating would remain the same. This impacts the rate at which a company can borrow money, and also is used by lenders to assess risk. Standard & Poor's has stated that there is no change in risk profile even with Sirius XM at 4.5x EBITDA. Very big news. Can you also see why getting 2013 EBITDA guidance sooner rather than later is critical? It is that number (be it $1.1 billion or 1.2 billion) that the debt holders will be using as their proverbial scale.

Yes, Sirius XM taking on more debt may be a heartache for some, but it should not cause too much worry. As long as the company stays at a level between 4.0x and 4.5x the biggest agency that rates credit is happy. This should tell you something. Believe it or not what Standard & Poor's did Wednesday was remove uncertainty. Investors should take note.

Disclosure: I am long SIRI, LMCA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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