Sirius XM: After $4 Billion, Where's The Growth?

| About: Sirius XM (SIRI)
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It is no secret to Sirius XM Radio (NASDAQ:SIRI) investors that the company is in the middle of a $4 billion share buyback program. The company has already purchased 476,545,601 shares for $1,602,360,000 through the end of the third quarter at an average price of just over $3.36 per share. In addition, Sirius XM will be purchasing an additional $500 million worth of shares from its majority shareholder, Liberty Media (LMCA), before the end of April 2014 at a price that will be nailed down next week.

The net price Sirius XM will pay Liberty will be between $3.5854 and $4.1173 per share according to an agreement between the two parties, which translates to a minimum sale of 121,438,807 shares and a maximum of 139,454,454 shares. It now appears that the price Liberty receives will be toward the low end of the range, perhaps around $3.69 per share, and the total shares sold by Liberty at that price would be 135,501,355. At the conclusion of the transaction with Liberty, Sirius XM will have purchased 612,046,956 shares for a total of $2,102,360,000. It will also have $1,897,640,000 remaining under its share buyback authorizations.

Investors should consider the following:

  1. Sirius XM had $716.8 million of cash on the balance sheet at the end of Q3.
  2. In Q4 Sirius XM will use significant cash in order to close the $530 million purchase of the Agero Connected Vehicle Unit, to retire approximately $540 million of the 7.625% Senior Notes due 2018, to make a $170 million payment to Liberty and the cash cost to launch a satellite.
  3. CEO Jim Meyer, discussing the company leverage, noted, "Allowing for completion of announced debt redemption, our leverage as of the third quarter was about three times and we anticipate this will be closer 3.5 times as we repurchase shares in the fourth quarter as well as close on the Agero transaction."
  4. Sirius XM will be making two additional payments to Liberty of $270 million in January and $100 million in April. These obligations likely keep that leverage close to 3.5x through April.

Leverage And Debt

The Sirius XM leverage objective has been a moving target. Former CEO Mel Karmazin first began discussing returning cash to shareholders once a certain leverage ratio was reached, and toward the end of 2010, he said:

From a leverage perspective, I frequently turn that question back around on investors and analysts who ask it. And the answer I get back is, the people generally think for our company and the media business that two to four times EBITDA broadly speaking is a good range of leverage to be in. So I think you can expect us long-term to be somewhere in that range.

It's a fairly broad range, and over time the parameters of leverage have changed from Gross Debt to Net Debt. In February of 2011, consistent with his prior statement, Karmazin said:

...So the obvious question that arises from this is what will we do with the cash that we accumulate over time. There are only three things a company can deal with a significant amount of excess cash, pay down debt, buy assets to grow the business or return capital to the shareholders.

...assume we keep leverage at a modest level like 3x adjusted EBITDA. In that case, we clearly would not be diverting much of the future cash generation toward reducing debt. In fact, we might more likely increase gross indebtedness over time as we continue to grow the business. So will we buy assets with our excess cash? Perhaps, but we haven't seen anything yet that's worthy of any meaningful investment or acquisition. Then will we return capital to shareholders, although I certainly can't quantify the amount or the timing for this, I think it is reasonable to expect that the company will return capital to shareholders over time.

Cash continued to build throughout 2011, and by December of that year CFO David Frear stated:

Based on the guidance that we've provided to the market, that we will be about 2x leverage in terms of net debt to adjusted EBITDA by the end of next year.

And as the cash continued to accumulate, the company began using that cash to reduce debt. By the end of the first quarter of 2012, there was a modest change in the company objectives. Karmazin continued to state that there were no accretive acquisitions available, and the company had begun reducing debt. After Q1 of 2012, Karmazin said:

We believe that a good use of our cash, certainly, would be to return capital to our shareholders. We've said that before, nothing has changed. ... So we will continue to be opportunistic as debt is offered to us for us to reduce our more expensive debt. As we are sitting with the cash, we're not getting very much interest, obviously, on that cash. And by retiring some of the debt, as David talked, about makes really good sense for our investors to do while we continue to build up cash in a significant way to consider returning capital to shareholders when the Board makes that decision.

Throughout 2012 Sirius XM reduced debt and reduced leverage, finishing the year with Adjusted EBITDA of $920 million, Gross Debt of $2,431 million and Cash of $521 million. That put the leverage ratio of Net Debt to Adjusted EBITDA at 2.1x, just as Frear had projected, and well below the "modest 3x" that Karmazin had discussed.

On the recent earnings conference call, Frear said:

Net of the retirement of the 7.625% notes which will occur tomorrow, we have $3.2 billion in total debt, $500 million of which is a deep in the money convert that comes out at the end of next year. Net of this convert, our leverage is only 2.3 times on our 2013 EBITDA guidance. We are underlevered, relative to our 3.5 times target and have plenty of liquidity to pursue acquisitions and continue our stock buyback program.

Meyer subsequently added:

Although, we have said many times that we have a 3.5 times leverage target that if we live to that target and look at everybody's model out there, so it gets you to the conclusion that (we'll) probably raise an additional $1 billion a year in net debt ...

With the exception of the non-callable 7% Exchangeable Notes, all of the company's higher interest debt will be eliminated by the end of this quarter. At the end of Q3, the company debt had climbed back up to $3.7 billion, although $0.5 billion was redeemed in October, reducing the net debt to $3.2 billion. Also, during the current quarter, Sirius XM will have used additional cash and borrowings (probably under its revolver) to pay a premium to redeem that bond, pay for the acquisition, launch the satellite and make its first $170 million purchase from Liberty.

These uses of cash will be partially offset by cash generated by the ongoing business. It is a combination of these factors that led Meyer to state that the leverage would be about 3.5x, where "x" is the Adjusted EBITDA guidance of $1.14 billion at the end of Q4. Note that 3.5x would put the net debt at approximately $4 billion (3.5 * $1.14 billion = $3.99 billion).

Now, consider what will likely occur in 2014. The company will complete its purchases from Liberty (an additional $330 million) and begin purchasing another $1.9 billion of stock in the open market, or perhaps a combination of open market and some additional Liberty purchases. The total of $2.2 billion to be spent on share buybacks - assuming the full amount is spent in 2014 - far exceeds the likely free cash flow to be generated by the business. This means that investors should expect to see Sirius XM go back to the debt markets to replace the short term borrowings under its revolver and keep its leverage at 3.5x.

That won't be the only borrowing for Sirius XM. The company will also have $502.37 million of its 7% Exchangeable Notes convert into 272.9 million new shares of Sirius XM stock. We can expect to see that $502.37 million be replaced.

If Sirius XM intends to keep leverage at 3.5x, and with Adjusted EBITDA guidance for 2014 at $1.38 billion, that would indicate that net debt would climb to $4.8 billion, with gross debt over $5 billion. So, other than driving gross debt up by $3 billion, what will the $4 billion share buyback have accomplished by the end of 2014?

Shares Outstanding

We can't simply look at the common shares outstanding prior to the start of the buyback and the projected shares outstanding at the end of the buyback and get a reasonable answer. Although, for the record, the number of shares outstanding at the end of 2012 was 5,262,440,085 and at the end of the third quarter was 6,134,596,655. That's not a typo. The shares have increased by 872,156,570.

Most of the increase is due to Liberty converting its remaining preferred shares into 1,293,509,076 shares of common stock. It is reasonable to consider these shares as part of an "Adjusted Starting Share Count" (ASSC). In addition, there were stock options that were exercised and restricted stock units that vested (27,505,245) and a partial conversion of the 7% Notes (27,687,850).

The conversion feature of the 7% Notes has made it a near certainty that they would be redeemed for shares for quite some time. Following Liberty's bailout of Sirius XM in early 2009 the shares began rising from less than a dime, and first traded above the original $1.875 conversion price in April of 2011. There were occasions when it dipped below that level, and a dividend in December of 2012 required the conversion price to be adjusted to $1.841. It has remained comfortably above both conversion prices since early July of 2012.

Using an ASSC that includes the Liberty preferred shares and all the shares underlying the 7% Notes being treated as common stock, we get to an ASSC figure of 6,856,515,881. As noted earlier, 476,545,601 shares have already been repurchased. How many additional shares is it likely that Sirius XM will be able to purchase under the current authorizations?

Future Share Repurchase

The precise price and number of shares for the $500 million Liberty sale to Sirius XM is in the process of being set, although the 135,501,355 shares mentioned earlier should be reasonably close. Prior to this sale, the average price paid by Sirius was just over $3.36, and the price had been moving sharply higher in Q3. The average prices paid in July, August and September were $3.58, $3.72 and $3.83, respectively. The average price for the quarter was $3.70.

When Sirius XM completes its purchase from Liberty by April of 2014, where will the price of Sirius XM shares be, and how much will the company need to pay for future share purchases? Obviously, it is an unknown, but if the price is presumed to be $4.36 - the mean analyst target on Yahoo! Finance - the remaining $1,897,640,000 could purchase 435,238,532 additional shares. That would bring the total to 1,047,285,488 shares purchased under the $4 billion authorization.

There are likely to be more options exercised and more restricted stock vesting over the next year, so the net effect on the share count of the share buyback could be closer to 1 billion shares. If more bullish price targets are used, the buyback becomes less effective and the number of shares purchased declines.

Impact on Free Cash Flow Per Share

The purpose of the share buyback is to increase the earnings and free cash flow per share. When Frear first discussed this at the beginning of the year he said:

Free cash flow per share is also growing at a rapid rate and it will grow faster as we begin to buy back stock. Based on our reported fully diluted shares and free cash flow, free cash flow per share grew from roughly 6.4 cents in 2011 to 10.3 cents in 2012.

Now, just for the sake of argument, if you assumed retire about 600 million shares in our $2 billion buyback program and assume our guidance of approaching $900 million in free-cash flow for 2013, free cash flow per share would trend towards $0.15 or roughly 40% growth over 2012's level.

Frear was on target, although the share buyback will be extended into April of 2014 and will use more than the original $2 billion. The 2013 free cash flow is now guided towards $915 million, and once the transaction with Liberty is completed, the fully diluted sharecount at the end of April will be about 6.3 billion, resulting in FCF per share that "trends towards $0.15."

As we try to project out 2014, the growth rate will slow. Even if the increase in EBITDA is all converted to FCF - which is not likely - the FCF would increase from $915 million to $1,155 million and the share count would be reduced to 5.9 billion. That would be trending toward FCF per share of $0.20.


Sirius XM appears to be very committed to keeping the leverage at or above 3.5x. That means increasing the debt and the interest expense that goes along with it. In the current low-interest rate environment, this can work reasonably well. And, as long as the company continues to space out maturities of its debt, it can reduce the risk associated with a spike in interest rates since, if necessary, the bonds could be redeemed with current funds from FCF.

The FCF is growing at a slower rate than in the past, and the FCF per share will continue to grow, and that will also grow at a decreasing rate. This will be due to an increase in interest expenses and a share price that is trending higher. The questions that investors need to consider is how much is less than $0.20 of FCF per share in 2014 worth and how much additional growth can be expected in the future?

Disclosure: I am long SIRI. 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.

Additional disclosure: In addition to my long positions, I have January 2014 $3.50 covered calls written against many of my long positions in Sirius XM. I also trade blocks of Sirius XM on a regular basis.