New Stock From Sirius Paves Way For XM's Financing
By Nat Worden
Of DOW JONES NEWSWIRES
A fresh offering of $440 million in stock announced by Sirius Satellite Radio Inc. (SIRI) on Monday raised eyebrows on Wall Street as the potential for share dilution at the company continues to be a chief concern for investors.
The latest offering, however, is aimed at helping XM Satellite Radio Holdings Inc. (XMSR) refinance its debt to meet change-in-control provisions under difficult credit conditions, as the two satellite radio providers move toward their long-awaited merger.
Sirius is letting the underwriters of a new $550 million bond offering from XM borrow its shares so that its satellite radio counterpart can refinance on terms that won't saddle the combined company with crushing borrowing costs after the deal is complete.
Shares of Sirius, meanwhile, fell 16% Monday to $1.88 as the company also reported second-quarter results, which included disappointing subscriber growth numbers. The deal - in which Sirius would swap 4.6 shares for each XM share - now values XM at $8.65 a share, 5.9% above that stock's closing price, which dropped 12% Monday.
XM's latest debt offering, which comes after it raised roughly $700 million in a deal that priced at a 16% yield last week, took the form of exchangeable bonds that can be converted into shares of Sirius at a certain price after the merger like a traditional convertible debt offering. This arrangement is aimed at allowing XM to refinance at more favorable terms but will be dilutive Sirius' shareholders after the merger.
Meanwhile, the demand for such an offering in the credit markets comes largely from hedge funds that can set up an arbitrage trade by buying the convertible bonds and shorting a certain amount of Sirius shares to hedge their position. Sirius shares, though, are listed on the Nasdaq's so-called threshold list due to heavy short interest in the stock, representing 12% of the stock's float. That makes it virtually impossible to borrow the shares in order to sell them short because regulators are cracking down on an abusive practice called naked short-selling, where traders make short bets in a stock where there are no shares available to borrow.
"The demand by hedge funds that dominate the convertible arbitrage market will be very little unless there are shares of Sirius available to be borrowed and sold short in order to hedge the long convertible position," says Michael Knox, the founder of Xtract Research and a former convertible bond fund manager. "If they didn't lend these shares, there would be no demand by hedge funds and therefore the pricing would be a lot less attractive to the company."
Sirius will lend out the shares to affiliates of Morgan Stanley & Co. (MS) and UBS Investment Bank, underwriters of XM's latest refinancing deal, in return for a fee. The company said the offering won't be dilutive to shareholders in the long term because they have to be returned to the company when the bonds mature in 2014. Also, for any shares that are sold short, the banks will take a long position in Sirius to offset it.
Sirius said that $375 million of the shares will be sold in a fixed-price public offering, and a remaining $65 million will be sold from time to time at prevailing market or negotiated prices.
"It's not uncommon in difficult-to-borrow situations for a company to take this approach," says Knox. "They're not technically issuing any shares here, so it's not truly dilutive, but it's giving hedge funds the ability to short the stock where they couldn't short before."
Sirius also said Monday that it expects to narrow its adjusted loss from operations for the second quarter to $24 million from last year's $79 million. It added that it expects revenue for the period up 25% to $283 million, meeting expectations on Wall Street.
Subscriber growth at Sirius for the quarter was up 25% to 8.92 million, a gain that Morgan Joseph analyst David Kestenbaum said was disappointing. The analyst last week downgraded Sirius to hold from buy.
"We believe integrating the two companies would be a major challenge in a healthy economy," says Kestenbaum. "Therefore, we are increasingly concerned that the company might have been too aggressive with its 2009 [outlook], especially in light of the continued weakness in the auto market, which both players are becoming increasingly dependent upon."
While the equity offering from Sirius may not dilute the company's shareholders over time, XM's convertible offering threatens to do so as holders convert their bonds into shares of Sirius. Citigroup analyst Tony Wible estimates total share dilution from the deal could amount to 4% to 7%.
Nevertheless, Wible holds a buy rating on Sirius with a price target of $6.50 based on the potential for cost savings after the merger from synergies between the two companies.
He said the satellite radio's equity offering is "an innovative way to deal with a tough credit market."
- By Nat Worden, Dow Jones Newswires; 201-938-5216; firstname.lastname@example.org
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