Sirius XM Investors May Line Up to Sue Sirius XM If Liberty Gets Another Sweet Deal

By Relmor Demitrius

Sirius XM investors can argue about what happened in February of 2009 till they are blue in the face.  One investor screams about Charles Ergen while another might explain to another about the evil nature of the banking system.  Others yell for Mel Karmazin’s head (CEO of Sirius XM Radio (Nasdaq:SIRI)) and claim he botched financing options before the deal with Liberty Media (NASDAQ:LINTA), now held within Liberty in their tracking stock Liberty Capital (NASDAQ:LCAPA), was even necessary.  Some blame the FCC or the NAB entirely.  Whichever train you board on this issue, there is sure to be a passionate and heated debate among stockholders as to what really happened from July of 2008 to February of 2009.  Let’s lay some groundwork first before we tackle the title of this article.

Sirius XM completed the merger in July of 2008 after the longest delay in FCC history.  Thinking back over the near monopolies formed under the watchful eye of the FCC, one immediately might begin to wonder what was so dangerous about merging these two companies?  Exxon/Mobile merger, which directly impacted every consumer of oil in the country, didn’t take anywhere near as long.  Putting aside this startling aspect of this process for one second, let’s now look at the time frame Sirius XM was allowed to merge as well.  In July of 2008 the corporate bond market was floundering, if alive at all.  Sirius XM went to the market and asked for over 1 billion dollars to refinance debt so they could be allowed to merge into one company in possibly the worst economic conditions in 3 decades.  They got the money, but the deal was terrible.  High interest rates and lent shares simply given to allow hedging not even acquired on the open market was considered the reason for the stock tanking to under $1.  Now add in a debt tower in 2009 that would also need an additional 1 billion dollars to remove, and the company was again facing the very real possibility of once again hitting the bond market only a few months later.  Did the bond market get better?  No.  It actually got worse.

Banks were struggling and the appetite for corporate debt dried up.  Sirius XM owed money due to maturity in February, May, and December.  The February debt was able to be cleared with cash on hand easily.  They also removed some by giving away shares at fire sale prices, with some conversions happening under 20 cents a share.  For a company that was trading over $3 a share even after the merger was announced, this was a huge blow to their ability to remove this debt.  If they had planned on exchanging debt for shares, their plan was derailed by a tanking stock and bond market.  Declarations of them going bankrupt and not being able to pay or refinance this debt were coming around every corner.  Apparently Sirius XM investors were going to get another “emergency” deal, and hopes of a huge post merger explosion of momentum and abilities to manage their debt load were slowly fading into gasps of panic and confusion.  Mel had promised the 2009 debt wasn’t a problem.  In fact, he went on record many times in 2008 to reassure investors that the bank debt due in May, the only part of the debt that couldn’t be exchanged for shares, regardless if Sirius XM wanted to or not, would be extended by the banks.  If they did this, the debt from February and December was now very achievable in clearing without a major injection of new money.

Even with a struggling stock price, and Charles Ergen buying bonds due in February and December and demanding cash and no shares, Sirius XM could pull this off.  Using cash on hand to remove the February debt owned by Ergen and shares to remove the balance, the February debt wasn’t the major issue with the debt load of 2009.  The banks, who of course wouldn’t want to see Sirius XM fail or go to bankruptcy where God only knows if they see one penny, would extend out the debt due.  The December debt could be removed with a new bond offering that would surely materialize with the kind of year on paper Sirius XM was expecting to have and did have, and it gave time for the credit markets to unfreeze and money to be available to them.  Worst case scenario, sometime before December they might have had to scrap by and use cash on hand again to pay December debt, maybe only needing to raise a measly 100 million dollars in new money, rather than all the money needed for 2009.  Only one problem with this plan.  No it wasn’t Ergen buying up bonds, although that didn’t help.  The banks refused to move the May debt.  In talks beginning sometime on this issue in 2008, to February of 2009, and knowing Sirius XM was in trouble if they didn’t do this for them, the banks simply said no.  We want you to either go bankrupt, and we will try to collect the money there, which is shocking considering these banks were underwriters of their bonds in the past, and Sirius XM had never missed a payment prior, as well as a vastly more efficient company now versus before, or obtain new money to pay us in the worst economic environment now in probably 100 years.  Remember, this is February of 2009 now.  It was bad in July of 2008, but it was much worse later.

So based on Charles Ergen trying to acquire a portion of the company or all of it for cheap by acquiring bonds due in February and December, they gambled Sirius XM couldn’t pay, which is suspicious because he would have had to know the banks were not extending their debt, hence making it a play just to gain a few dollars on buying and selling bonds versus an actual take over attempt, which Mel said it was later.  Let’s face it.  Buying February debt in hopes to drive Sirius XM into a bad deal for themselves is foolish and irrelevant if the May debt is extended.  Pure and simple as that.  The bulk was due in May, and was not even possible to be removed other than with cash.  Why didn’t the banks extend their debt?  Only they know that.  Maybe they needed the money desperately, in fact so desperately, they were willing to bet it all or nothing in bankruptcy.  Not sure.  Maybe they knew someone would loan Sirius XM money at a terrible deal and didn’t care, as long as they got their money.  Maybe it was a play on the short side, who knows.  Anytime you need to involve a bank heavily in your corporate financing, you are asking for trouble.  Sirius XM of course wouldn’t exist to that point without these loans so its a double edged sword, catch 22 sort of thing.   You dance with the devil, you’re going to get burned.  It’s as simple as that.

This was Sirius XM second emergency, possibly forced on them by situations outside of their control.  Was the NAB going to file a last second attempt to block the merger in July of 2008, hence hurrying Mel into making a bad deal to close the merger quickly?  Maybe.  Did Ergen and the banks force Sirius XM into looking to Liberty Media for new money?  Possibly.  Did Liberty get a great deal on circumstances they on paper had zero to do in creating?  Yes.  In fact, as it turned out, they got 40% of a 2.7 billion dollar a year revenue cash cow for free.  Yes that’s right.  I said free.  They ended up paying zero dollars for 40% control of billions in assets, cash generating abilities, and spectrum.  Wow.  Liberty made out like a bandit.  What great timing for them.  Malone is the luckiest man in the world, obviously.

Now since news of a request for early termination/clearance from the FTC in regards to some type of purchase Liberty Media (NASDAQ:LINTA) has in regards to Sirius XM, speculation is running rampant on what it could entail.  I have heard some startling suggestions from incredibly intelligent people to what this deal might encompass.  So startling it may drive the levels of reason and accountability of stockholder and management to new levels of frustration.  Impossible you say after all this?  Not entirely.  Let me explain.

In December of 2008, Sirius XM knew about what Charles Ergen, the man behind Dish Network and Echo Star, was attempting to do.  In probably August of 2008 Sirius XM knew the banks kept saying no on extending the May debt.  In September the banks said no to extending the May debt.  In October the banks said no to extending the May debt.  In November and December they received the same answer.  So here you go. Its late 2008 and Sirius XM is facing a debt load that now is looking like it may indeed need new money to remove.  So 75 days later, Sirius XM went behind their stockholders backs, necessary or not, I will not say one way or the other, and agreed to sell Liberty Media 40% of the company in preferred shares for a bridge loan of just over 500 million dollars.  They ended up getting new bonds just a few months later, how sad for Sirius XM, and paid back Liberty immediately the money loaned.  So for a loan of 2 months Sirius XM lost 40% of its company.  Blame who you want, those facts are the facts.  This was now the second “emergency” stockholders had no choice in, and both were terrible deals for stockholders.  The no vote to stockholders on the Liberty deal was done by invoking a Delaware corporate law stating if a company doesn’t have sufficient time to get a vote of approval from stockholders, and bankruptcy is staring them in the face, they are allowed to approve the deal with a vote of the board of directors, instead of taking the issue to stockholders.  Now this brings us to the present day.

Economy is improving.  Sirius XM is now full year cash flow positive.  They are no longer shedding subscribers, but now adding them again.  They have no major debt due till 2013.  It is very possible Sirius XM could grow their cash on hand from 380 million to over 530 million by the end of 2011.  Auto sales are improving nicely as well.  Sirius XM is unarguably in their best financial position in their history due to royalty charges and cost cutting measures that have aided in almost every line item.  Their situation today is hardly an emergency.  In fact, one could argue the exact opposite.  They have been able, since the Liberty deal to refinance over 500 million dollars in debt due in 2013 and they acquired all the money necessary to pay Liberty back 100 percent of all borrowed money.  Now let’s look at what this new FTC clearance might mean.

There is talk that it could be a debt for equity swap, with Liberty hungry for Sirius XM debt on the open market, acquiring over 500 million dollars of it since they entered the picture.  Some are suggesting this will be removed with a preferred share deal with Liberty that would bring them to their maximum amount of Sirius XM they would be allowed to own, 49.9%, at least right now.  If they are preferred shares, once again Liberty is shielded from additional dilution in the future, as is their current 40% stake.  This is permanent ownership.  Its not even shares acquired on the open market or a tender offer, which I think this is what is going to happen. Is this another huge chunk of a company given to Liberty simply because they have 6 board seats and influence now going forward with future plans.  In my estimations, there is a very real chance Sirius XM never needs to acquire new cash again.  Their debt load today due to increased revenue and refinancing debt off of 2013 and beginning to pay down debt due in 2011 indicates a clear path and intent.  Sirius XM might not even need to grow themselves out of this debt, they simply need to continue as they are doing, and they can survive with the only added dilution already being priced in, and sitting in their outstanding share count, the shares needed to remove the 2014 550 million in convertible bonds that have a $1.87 conversion price.  With years to achieve that price, and improvements in the balance sheet happening by the quarter, it’s not a stretch to assume this debt with be removed with shares.  But other than that, I see no further reason to give ownership away for debt anymore, at least not at these prices.  If the deal is for over $2 a share, I would still have a problem with it, just less of one.  The last company Sirius XM should be doing any favors for is Liberty Media.  They already received 40% of the company for free, without a stockholder vote.

Now they have the audacity to want 10% more for simply buying bonds?  Can I get preferred shares from Sirius XM that is undilutable if I buy some Sirius XM debt?  Of course not.  So why should Liberty be allowed to, especially when this time I see no emergency, and no reason to do so.  Whether stockholders bought your previous 2 emergency scenarios or not, you will have zero chance convincing stockholders this time selling shares for debt directly from your company to a debt holder is a good deal for under 1.87 a share, as I think that price is even a steal, and didn’t agree with that terrible conversion price at the time either.  Mel and others can argue, but its trading at 87 cents now?  Why not sell shares for $1 or $1.20 when you were willing to sell them a year ago for 12 cents?  Timing, that’s why.  Also the who is the problem too.  Let Liberty go to the open market, or tender an offer for shares if they want them cheap now.  Let’s see what happens to the price if its leaked Liberty is trying to grab shares on the open market in huge amounts.  Let’s see where large block holders are willing to sell at.  Why make it easy for them?  Since I don’t buy the current price as fair value, I know Sirius XM can’t either, in fact they have stated as much themselves.

If Sirius were to just give shares to Liberty for debt, they would have to give them 40% more for free, due to Liberty being undilutable, even to themselves.  Any time Sirius XM takes 10 shares from authorized to outstanding, 4 new shares go to Liberty, even if its Liberty getting them.  So this is a terrible way to remove debt, and why I don’t think it is what is going to happen.  A preferred stake?  Why?  I don’t see one benefit to Sirius XM for doing this.  In fact I see reasons and grounds for a lawsuit, as it would violate shareholder interest.  This company’s financial position simply does not support Sirius XM giving away shares or preferred shares and control of this company at these prices, or even anywhere near these prices.  Try to buy 100 million shares on the open market Liberty before people catch wind of it, and see where the price goes to.  I’m willing to bet $1 is beyond taken out in that situation, and probably 1.20 or higher as well.  Simply no shares in this range to give in that amount.  Well you say, what about $1.50 then?  Once again, no.  Doesn’t matter what kind of premium Liberty might pay for these shares, the last thing Sirius XM should be doing is making it easier for Liberty to acquire more control.  I would say this if I were Mel to Liberty.  You want a larger preferred stake?  For $3 a share, you can have 9.9%.  At least we recoup something from giving up 50% of the company.  1.20?  I don’t see any reason to dilute your ownership to remove debt, cash can remove at that price.  In fact, as CEO who is working for stockholders, all stockholders, not just ones who bought at .12 cents, a sell under $3 a share would be a joke.  $2 a share I would still consider that stealing, as I really do think that if Liberty tried to buy 10 % of the company on the open market right now, $1.50, forget $1 would be long history.  This would be the ideal situation, as they remove shares from the float, and Sirius XM keeps their percentage of control.  These shares would probably never trade, and the tradable float would be reduced greatly.  Preferred shares are undilutable, so any shares Liberty buys on the open market is not increased.  Liberty is the last company Sirius XM should be doing any favors for.  In fact, one more favor and Mel might find himself in front of a courtroom more than he would like in the coming years, instead of enjoying running a radio giant he always dreamed about.  Any new deals with Liberty opens up the old deals, and I’m sure Sirius XM will look to avoid this can of worms in the future.

So in conclusion, I do not think this is a debt for equity swap for preferred shares, nor do I see new shares for authorized being sold here.  This is a tender offer or an open market attempt for either 5 to 10 percent of the common.  This will have to suffice for now with Liberty, as they are simply adding to their stake now, under $1, before this stock is well over $2 or $3 a share by the time they can acquire more than the 50%.  When you get 40% for free, the last thing you should be doing is going to the company and asking for more.  The last thing Mel should be doing is saying yes.  Does Mel really want to say this time is an emergency too?  Will he try to rationalize it based on the low trading price Mel himself says is under representing this equity?  I don’t think anyone has that kind of gall.  With a company’s sketchy relationship with stockholders to this point, I would think the wise course of action here is one of full disclosure and common sense at this point.  Stockholders are watching you Mel.  We are watching you very very closely.

Long SIRI