Will Sirius Deal Take Liberty To $138?

| About: Sirius XM (SIRI)
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As a lot of you already know, Liberty Media (LMCA) is making concrete plans to take control of Sirius XM Radio (NASDAQ:SIRI). In a filing with the SEC on Wednesday, it was revealed that the forward agreement of 302 million Sirius shares will be closed by July 6. The filing also shows that Liberty has been on a 60 million-share buying spree in the open market for the last two days. According to Liberty, this will bring its ownership to 46.2% of Sirius. This is what I'd call "massive insider buying." Many investors agree that insider selling occurs for numerous reasons, but insider buying means good times are ahead.

And the good times may not be limited to Sirius. Because not only is this good for Sirius XM, it is also good for Liberty. According to the Maxim Group, Liberty shares will rise dramatically. Analyst John Tinker said:

We are raising our LMCA price target to $138 based mostly on our forecast SIRI XM Radio, Inc. (Buy, $3.20 PT); Using our SIRI target price enables investors to gauge the upside of both stocks and assess their respective weighting. SIRI is the 'pure play'...

In other words, when the price of Sirius is $2.15 and Liberty owns approximately 40% of around 6.5 billion shares, its Sirius shares are worth $5.59 billion. When the company purchases more shares (for a total of 46.2%) and those shares are worth $3.20 later in the year, its stake in Sirius is suddenly worth a whopping $9.6 billion. Many investors think that John Malone is trying to control Sirius' price and keep it down. I can see how it would seem that way. He wants to buy it cheap. And as part of the forward agreement that he has entered into, he will get 302 million shares for $2.15 a share. Which is a rock-bottom price. And the shares bought on Tuesday and Wednesday were (as averaged) cheaper than that.

But some investors may feel that what he did was unethical. According to the SEC documents, the "hedge" was initiated back in December while he was in a standstill agreement not to purchase shares of Sirius before March 6. And he failed to mention this piece of information to the FCC in the application for de facto control. The application was denied because Liberty did not show any signs of buying a bigger stake in Sirius beyond its 40%. The announcement earlier this week gave the impression that Liberty would not pay a premium for Sirius shares (as many had hoped). This sent the shares tumbling, which Liberty then took advantage of by buying over $126 million worth of Sirius at a bargain basement price. Oops.

Chart forSIRIUS XM Radio Inc.

However, what Malone did was perfectly legal. Liberty had the right to buy up to 49% of the company before the March 6 date. And it had the right to announce that, and then buy more shares on the open market. As to whether it could legally withhold this information from the FCC -- I don't have an answer for that. But now that the cat is out of the bag, Sirius shares should go up dramatically. It seems obvious that Liberty wants to have control of the annual shareholders meeting on May 22. According to an article by Seeking Alpha author Crunching Numbers, Liberty CEO Greg Maffei made this statement in February:

...you buy up to 51%, you get yourself into a position of hard control, you then can direct how their cash can be deployed and how you then have a systematic shrink there which increases your ownership percent at the Liberty level.

Loosely translated, this means a share buyback is Liberty's goal. Which is not a surprise to anyone. But for some reason Malone must feel he has to have the 51% going into the meeting. I thought Malone would use the buyback to take the company over 51%. However, there was a lot of tension between Liberty and the Sirius Board with the FCC application that was dismissed in favor of Sirius on Friday. Maybe he feels the board would vote against a buyback now. Hopefully they will all be amicable in this situation. The current team running Sirius has done a tremendous job, and I would hate to see that team changed in any way.

One thing to watch for is a "fake" play. Liberty could buy another 4% of Sirius, which would take it over 50%. This gives it control of the annual meeting, where it can force a buyback. Then, after the dust settles, it can wiggle out of the deal in July. According to the article by Crunching Numbers that I mentioned above, the forward agreement could be settled for cash. I asked Crunching Numbers if it was possible that Liberty could exercise its option to buy that stock before the third quarter. Crunching Numbers said:

I suppose it is possible (and the language in the 13D certainly doesn't preclude the possibility), but they can also settle it for cash. It may not make sense to settle it early unless they feel it's necessary to show absolute de jure control by the date they re-file the FCC petition.

That said, I think they will have the 51% lined up by the 22nd, regardless of whether they have physical possession of the shares. Remember, the preferred shares can't be used to put up a slate of directors, so they would also have to convert those (and the 7% note) to common to have full control.

Does it make that much difference? Mel and the Sirius board would have to know by now that Liberty is taking over. All the rest is merely a formality.

Normally I would not even think something like this could happen. But from what I have seen regarding the Liberty filing for de facto control of Sirius without permission from the company, nothing would surprise me. And hopefully the Sirius board will make sure that Liberty's ownership is actually above 50% before they hand over the passwords for the refilling of the FCC application (which must be done within 30 days). I am sure that Sirius management will make it known to the FCC that the forward hedged deal occurred before the prior application, and it was not disclosed at that time.

But anyway you slice it, this deal will raise the value of both companies for shareholders. As John Tinker said, Sirius is the "pure play" because its value will go up so much with a buyback. Its performance has been absolutely stellar. And because Liberty will own such a large chunk of Sirius, it will go up substantially. One word of warning, however: Liberty may either leave things as they are, or spin Sirius into another independent company. That stock might not be under the Liberty ticker, LMCA. Sirius shareholders own the stock directly, and therefore would be swept along with the spin-off. Liberty shareholders, on the other hand, have no such guarantees. Again: Sirius is the pure play.

Disclosure: I am long SIRI.