By now most everyone that follows the media is well aware that Howard Stern’s production company, One Twelve Productions, and his agent, Don Buchwald have filed a lawsuit against Sirius XM Radio. The suit alleges that Sirius and/or Sirius XM Radio have failed to pay certain performance bonuses due to them based on the company’s subscriber numbers.

There are several factors that Sirius XM investors need to consider…

Immediate Impact

The immediate impact began to show through in after hours trading. This is a potentially HUGE lawsuit, worth hundreds of millions of dollars, brought against the company by one of their top on-air personalities. The stock will likely suffer because of this overhang. This is not uncertainty about whether or not Stern will retire or move to another medium, it is uncertainty with massive financial implications. Watch for an immediate negative impact followed by a period of time where the overhang of such a large suit will degrade investment value.

Class Action Suit

Given the language in the lawsuit, there is serious potential that a class action suit against the company on behalf of the shareholders will come up. Stern’s side alleges in the suit that they brought up the bonus issue several times, including during the recent negotiations when Howard signed a new five year deal. It could be argued that the company breached their duty to shareholders by not bringing to light the significant risks associated with these bonus payments.

UPDATE: It would appear from some email communications I have received that many people do not understand what is being stated here. This site is in no way promoting a class action suit. What is being stated simply recognizes that we live in an extremely litigious and opportunistic society. Often, when things like this suit happen, attorneys look for a way to bring a class action. That is all that this site is saying. We ARE NOT saying such a suit would have merit, nor that such a suit would succeed. The purpose of mentioning this possibility was to explore possible implications. Investors MUST bear in mind, as stated at the bottom of this article, that we have only seen one side of the case at this point.

Liberty Impact

Liberty Media holds preferred shares that equate to 40% of the company no matter what the situation. If Sirius XM needs to dilute shares to pay bonuses, the Liberty stake is still 40% of the company. This situation is now a virtual guarantee that Liberty will not be converting their preferred shares any time soon. Why would they? If they converted now, they lose potential share growth via any dilution Sirius XM may have to do. In effect, with their preferred stake Liberty is insulated from the issue.

In addition, with a suit of this magnitude on the horizon, Liberty may have new considerations on what they may or may not do. Some people think that Liberty may at some point make a move to acquire Sirius XM. With potentially hundreds of millions of dollars at stake, the value of Sirius XM is in question. In one sense a cheaper Sirius XM may be attractive, while on the other hand the risks of the lawsuit may make the company unattractive. All that matters here is what Liberty’s John Malone thinks. It will be interesting to see how this plays out.

The Stakes

The original Howard Stern contract called for bonuses to be paid if Sirius beat internal subscriber estimates in any year by 2, 4, 6, 8, and 10 million subscribers. In other words, Howard was eligible for up to 5 bonuses per year. Now Stern’s side wants to count the XM subscribers in their totals. This would mean that there are several bonuses that they still feel are due. Because these payments were not made, and a suit was filed, the plaintiff is also seeking interest and costs. We are talking about hundreds of millions of dollars, possible dilution, and the impact of Liberty gaining even more shares by keeping their preferred stake.

Long Term

This suit will not likely be settled overnight. The longer this overhang exists, the harder it will be for analysts and the street to attach any premium to this company. This could keep a ceiling on where the price of Sirius XM stock can go. Even with a good financial performance, SIRI will have the baggage of this suit. If class action suits get added to the mix, the story becomes more grim.

What investors need to consider is that this stock may now have limitations that were simply not anticipated by investors. The implications could be substantial and the annual shareholder meeting will certainly be interesting. Watch for analysts to revisit Sirius XM with consideration to the lawsuit as the basis for new price targets that investors may not appreciate.

On Air Battle

Howard Stern has always shared what is happening in his personal life with his audience. This will likely be a subject on the show. Howard is no fool, he will stick to his story and not jeopardize his lawsuit, but will likely slam Sirius XM along the way. Depending on his mood, some pretty quotable lines may come out of the show for quite some time. Do not look for any other talent to bring up the issue. Sirius XM will most likely put out a gag order on other channels.

Possible Defense

Sirius XM does have possible defenses. They can argue that the XM subscribers should not be counted. They can use the “BEST OF” aspect of the XM subscriber base to show that the internal estimates were not beat. They can argue that the subscriber bases were counted separately until 2011. Certainly Sirius XM’s legal department felt that the bonuses were not due and must have felt confident in that assessment. Bear in mind that all we have seen to date is Howard’s side of the story

Watch closely, not only this week but, until the issue is resolved.

Position – Long Sirius XM Radio