What Is Happening With Sirius XM Defies Logic

| About: Sirius XM (SIRI)
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For Christmas my Mother bought me the book Million Dollar Portfolio by David and Tom Gardner. Since it was published in 2009 I figured it was pretty outdated. But it actually has a lot of pertinent information in it. I realized after reading the book that I was listening to my logical brain. I wish that I could have read it a couple of years ago. I would have saved myself from making some very bad investment decisions. It came to mind as I was reading Cameron Kaine's article yesterday. He discussed using logic when determining the value of a stock such as Sirius XM (SIRI).

Gardner on the other hand speaks of the "logic of patience" and he says be very wary of your brain:

Warning: Your brain is likely to make it very difficult for you to succeed as an investor. When master investor Warren Buffett was asked by a group of business school students early in 2008 why so few people have been able to emulate his success - despite the tomes that have been written dissecting his investing philosophy - Buffett responded, "The reason gets down to temperament. People want to make money fast, but it doesn't happen that way." Successful investing takes time. Years and years. Even decades.

Right now some investors will see Sirius has dropped from a high of $2.35 Monday morning, and listen to their brains that are telling them to sell. The Pros are counting on that. But the experienced investor is buying more Sirius shares on the dips. Look at the dips in the last 3 months. They are followed by even bigger gains.

I am seeing a lot of posts about March 6. That is the day that Liberty Media (LMCA) was set free to increase its current 41% stake in Sirius. The Bears are saying March 6th has come and gone with no activity from Liberty, so the stock will now surely crash. If you read my article last week, you will remember that I said buyback NOT buyout. There is a major difference. In that article I quoted a Wall Street Journal story of last Friday which said that Liberty would prefer to acquire Sirius through a Sirius buyback. This would allow Sirius to operate independently as a spinoff, yet increase Liberty's stake with no additional cost. That WSJ article was the main catalyst in making the share price go up on Friday. It was not the prospects of a buyout on March 6 that caused the sudden spike. People have known about the Liberty deadline for 3 years. So why would they all decide to buy on March 2?

Now, I am not saying to take your eyes off the table either. The spike in price on Friday was caused by 45 million shares being purchased all at once. Even though Liberty said they will take over Sirius through a buyback, they may change their minds.

A buyback is not instant gratification that will pay off in March. However I will tell you that when one is officially announced, the stock will pop significantly. If you are unfamiliar with how buybacks can help the share price go higher, you should read an article I wrote about the subject. Now if you are still not convinced, consider this Cinderella story.

Dillard's (NYSE:DDS) was "shorted" and almost left for dead during the financial crisis of 2009. The stock went down to under $3 a share. The economy began to improve and Dillard's announced a buyback plan in 2010. This plan has continued for the last several years. The stock shot to a high of $60 last summer and then fell back to just under $40 during this past financial crisis. When it was announced that Dillard's would begin another aggressive buyback on February 29, the stock shot back to over $60. As another article on Seeking Alpha shows, companies with cash can do well using buybacks:

Dillard's: The apparel and home furnishing retail business announced a $250 million repurchase program which represents a massive 8.1% of its outstanding shares. The company has followed a very sensible repurchase strategy. Over the last two years it repurchased approximately 20 million shares at prices as low as $20 in 2010. In total the company retired 27% of its outstanding shares already. At today's share price of $60 the new plan would allow the company to repurchase another 4 million shares.

On February 2, Dillard's stock was at $43. On February 23, Dillard's announced positive earnings results, and on February 29 the buyback was made public. Then the shares soared to $62 on the news:

I really feel that the Sirius chart will look like this sometime in 2012. Dillard's went up 48% in one month. If Sirius did that, the price would be $3.31. Dillard's did not go up like this because of "buyout" news. This was good earnings combined with buyback news. The buyback has not even happened yet.

If you think this is a totally different type of company and totally irrelevant to Sirius XM, consider this. According to the Sirius Income Statement and Balance sheet dated 12/31/2011 there are 3.753 billion common shares outstanding. And there are 6.501 billion total diluted shares which includes Liberty's stake. Using these numbers gives them 2.748 billion shares if their preferred shares were converted to common, or 42%. Their website shows they are at 41%, but this gives you an idea. When it comes to exact shares these change all the time due to employee options etc, and the counts are different depending on the site. But we will use these numbers for our model.

The stock closed yesterday at $2.22. If you multiply this by 3.753 billion shares you get a market cap of $8.33 billion. This is what the market thinks that part of Sirius is worth. Now let's look at the future worth. Checking Barron's and Yahoo Finance, they both give price targets of $2 (low), $2.50 (middle) and $3.20 (high). Normally I go with the middle target, but since the stock was within 15 cents of that Monday, it is too low. So we will go with $3.20 which I think is also low, but the analysts are not factoring in a buyback like we are about to do here. If the shares stay the same, then multiply 3.753 billion by $3.20. That makes the new market cap for the end of 2012 $12 billion. This is what that part of the company would be worth then.

Now let's assume that Sirius does a buyback. If we round the common shares to 3.75 billion and Liberty's shares to 2.75 billion, it would take approximately one billion shares to give Liberty more than 50%. At today's price that would be $2.2 billion. Sirius does not have that kind of money without going further into debt. However they will have $1.5 billion in cash at the end of the year. It is not that farfetched to think that they could buy $1 billion in stock. At the current price that would buy 450 million shares. This would bring the outstanding common shares down to 3.303B (3.753B - 450M). The market cap of $12B would be the same, so the new share price would be $3.63 ($12B divided by 3.303). So this is actually a 64% gain, even higher than in the Dillard's comparison. To accomplish this Sirius needs to start buying shares pretty soon to get these prices.

According to the WSJ article Liberty wants to use the buyback to take them over 50%. Are they going to lend more money to Sirius to actually buy the one billion shares needed? If this were to occur, the share price would be even higher than $3.63. Why would Liberty do this? Just using the first model of a buyback of 450 million shares (where Liberty does not help in the buyback) would make their 2.75 billion shares worth $10 billion (at $3.63 per share). And they did not even spend a dime.

This is one of the reasons why so many investors see Sirius as a deal at $2.22 and consider it undervalued. They see the future. So even though Buffett is not always right, I am going to listen to him this time, throw logic to the wind, and be patient. I might even buy more shares.

Disclosure: I am long SIRI.