On May 30th, 2010 I published an article on Seeking Alpha titled, "Understanding Sirius XM's Potential Share Buyback and Liberty Media Stake". The premise of the article was developed after I attended the annual meeting of shareholders for Sirius XM Satellite Radio (NASDAQ:SIRI) held on May 25th.
While attending the shareholder meeting, Sirius XM CEO Mel Karmazin took a question from a shareholder in reference to whether a stock buyback would be common only, or if the company would try to buy back some of the preferred shares held by Liberty Media NASDAQGS:LCAPA). In answer to the question Karmazin stated that he would have to be careful about buying back common only so as not to increase the Liberty stake to a point that would give the company control. He went on with an example that if he were to invest $1 million into a buyback that he would put about $600,000 of it to common and $400,000 of it to Liberty's preferred thereby keeping Liberty's ownership stake where it was. He further stated that there is no mechanism for Sirius XM to force Liberty to sell their preferred if they do not want to.
One of the first things you the reader needs to understand is that I was not at the shareholder meeting as an investor (although I do hold shares). I attended the meeting as someone who has written about and covered satellite radio for several years. My ears are not tuned to viewing and listening to the meeting from a personal investment standpoint, but rather as someone who would be reporting on the event. Upon hearing what Karmazin had to say about the issue I was taken aback. I had long held the belief, as have many investors, that the Liberty stake was 40% no matter what. What Karmazin had spelled out went directly against my belief. After the meeting I took the time to confer with management at the company specific to the issue. I then went home and began to dig through filings that my eyes had not looked at in over two years. After doing that I still went back to discussing the issue with management several times.
I first broke the news about the stock buyback issue on Playground Radio's May 25th show the evening of the shareholder meeting. Immediately upon sharing this news I had several people, including purveyors of other satellite radio websites become very quick to call me out as being wrong and generally disparaging me on the chat room associated with the radio show.
Over the next few days I continued to research the issue and speak with the company (as well as Liberty) about the issue. It was only after thoroughly convincing myself that I was wrong for over two years, and eating my slice of humble pie that I published the article on Seeking Alpha. Immediately upon publication I had several people, including new websites, call me out as being wrong, and that 40% was 40% no matter what and that the Liberty stake would not increase if Sirius XM conducted a share buyback of common only.
Subsequently, the debate seemed to shift totally away from the concept of a buyback increasing the Liberty stake to a specific line in my Seeking Alpha article, "While the Liberty stake currently remains at about 40% (right now it is actually in the 39% range), that number is not cast in stone. What is cast in stone is how many common shares Liberty gets if it does convert its preferred shares." The purpose of that line was to get investors to realize that the Liberty stake is not 40% of the company no matter what, but instead a set number of share just like yours or mine. The fact that Liberty has anti-dilution rights was well known and well established at the outset of the Liberty deal with Sirius XM, and not really applicable to the premise of the article which was that Liberty's stake was not 40% no matter what, and that a share buyback of common only would increase Liberty's percentage of ownership. This is almost as if I was writing an article about air quality and called the sky blue, and now people wanted to argue that it is red at sunrise and black at night instead of discussing air quality. It is as if they were so ardent in their initial reaction that they are now seeking ways to somehow and in some way be right on a technicality.
For all intents and purposes the Liberty stake has indeed been identified as 2.586 billion shares. The number is "set in stone" in the same manner yours or my shares are. Yes, there are adjustment events for stock splits, etc. but in the end these adjustment events only serve to allow for the mathematical adjustment as it relates to a split. Such adjustments would be made to the Liberty stake as well as yours and mine.
Over this entire period I received email's calling me a liar and stating, "how could you mislead investors on such an important issue". It was amazing to me that some would be so set in their ways that they simply refuse to look at the facts or make a simple phone call to investor relations. The debate raged on, and so did the disparaging comments. Other radio shows were dedicated to what I had said, and characterized me as someone misinforming investors. The situation is actually quite sad, because at the end of the day people will indeed come to realize that indeed the Liberty stake would increase if a share buyback of common stock happens and Liberty does not participate in tandem with preferred. To this day there is a small and boisterous group that still does not understand that the Liberty stake would increase.
On June 1st, 2010 Demian Russian of Satellite Radio Playground and I took the time to interview Professor Anthony Page. Professor Page is a Professor of Law & John S. Grimes Fellow at Indiana University School of Law–Indianapolis. He specializes in corporations, corporate governance, and mergers & acquisitions. His scholarly work has been cited by several U.S. courts, including the Supreme Court and four state supreme courts. I would encourage Sirius XM investors as well as Liberty Capital investors to listen to this show. During the interview Page stated:
"Well, as I read the various documents that have been mentioned...and to be honest I do not see much dispute about this. The number of stock that Liberty Media could convert it's preferred stock into would stay constant, which is a little over 2.5 billion shares. Now if the number of outstanding shares declines, as would happen in a buyback, that would mean that their percentage ownership would increase. So for instance...if Sirius XM bought back 5% of the common and no preferred, the Liberty stake would become something like 42%."
The Professor then went on to address Section 9B of the certificate of Designation dealing with anti-dilution adjustments. He stated:
"The clause that the listener is referring to is called section 9B anti-dilution adjustments. Now, though I hasten to add that that while title holds no true weight, it does tell you what it is intended to do. It is intended to be a means against dilution. It is intended to protect Liberty from being taken significantly below their approximately 40% ownership. So that's what the provision means and is intended to do. Now 9B, that particular clause applies to three situations. One is that if a dividend is paid, or a distribution is paid in shares, in other words a share dividend,...Now that makes sense...in the event Sirius XM decided to pay a stock dividend of 1 share of stock for every 5 owned, that would result in Liberty being diluted because they would not collect that particular dividend on their convertible preferred. That would result in the conversion rate changing, and in fact the number of shares being issued would go up so that their potential ownership interest would stay constant. The next one in 9B is the subdivision of common stock into a greater number of shares of common stock...so that's just a forward stock split. In that scenario if there is a stock split, again we would adjust the number of shares Liberty gets, but again the adjustment is done so that their ownership interest stays the same. So you have a company and it is worth a certain amount...you can divide that value into how many shares there are...and if you double the number of shares, you haven't increased the value of the company at all...you have merely doubled the number of shares, and thus each share is worth roughly half of what it was before, so again, the point of these provisions is to be sure that Liberty's percentage ownership interest remains roughly the same. The third provision, which is perhaps what the listener is referring to and the only one where I can see any potential ambiguity, read 'combine the then outstanding shares of common stock into a smaller number of common stock. Now, combing the then outstanding shares of common stock is referring to a reverse split, where for example you take 5 of the shares and give them 1 or 2 in return. Again, the value of the company hasn't changed at all, but if Liberty's preferred isn't effected it would give them a much larger share and that also wouldn't be right. So again if you look at the whole purpose of the anti-dilution adjustment, it is to ensure that Liberty's ownership in the company remains comparable. Now when I read this clause, I suppose sure you could sue over that, in America anyone can sue anyone for almost anything, but I can't imagine this case going very far. There would need to be an enormous amount of evidence for a case to even begin. So I guess what I am saying is that I do not see any significant ambiguity in here in what is intended by the provision or the plain language of this provision. I do not think that a buyback could possibly qualify as the then outstanding shares, rather it is simply a buyback, the company buying back shares from those shareholders that want to sell some or all of their shares. I wouldn't want to say that this would preclude a lawsuit because people can certainly file lawsuits over almost anything, but I am just not seeing ambiguity here that some of your listeners or some of the commentators are seeing."
In a recent article yesterday published by King of All Trades, in response to my original piece on Seeking Alpha the author took an exact opposite position to my contention that a stock buyback of common only would increase the Liberty stake. In the piece the author goes through several filings to support his position. I have gone through all of these filings as well, and had once interpreted them in the same manner this author did. Upon looking at the issue with a fresh pair of eyes, eating my own humble pie, I had to revise my opinion. My change of opinion is based on statements by Mel Karmazin, discussions with Sirius XM and Liberty, discussions with legal experts, and simply taking the time to dig deeper.
The author states, "In March of 2009 Liberty had to register a form 13D, which is required by the SEC when anyone obtains more than 5% of any class of a companies shares. A statement of beneficial ownership among other things is required to be on this form. So saying Liberty owns 40% of Sirius XM is impossible for this form. They need an actual share count. So the date March 4th was used as the “snapshot” of Sirius XM’s total outstanding shares at the time, to determine how many shares exactly is the 40%."
The filing is much more than just a snapshot. You first need to consider the deal. In February of 2009 Mel Karmazin and John Malone reached a deal. There was a lot happening at that point, and the deal they reached would need to pass muster of regulatory agencies. The deal was also structured in phases with responsibilities laid out for both Liberty and Sirius XM. In February the parties had a responsibility to let their respective shareholders know that a deal had been reached even though the workings of that deal would take some time to come to fruition and pass regulatory muster. That announcement was made with an 8K filed by Sirius XM. In that filing the company stated, "Upon expiration of the applicable waiting period under the Hart-Scott-Rodino Act, the preferred stock will be convertible into 40% of our outstanding shares of common stock (after giving effect to such conversion). Issuance of the preferred stock is subject to the satisfaction of certain conditions, including the conditions to funding under the XM Credit Agreement described below." The Hart Scott Rodino act waiting period expired on March 30th, 2009. This is some of the key language that led to the confusion many investors had. Simply stated, people read 40% and then from that point forward assumed that the preferred would always convert to 40%. On March 4th Liberty completed their phases of the deal with Sirius XM, and at that time received their stake in the company, which then equated to 40.15%. It was Liberty fulfilling their obligations under the agreement that established the number of shares they would get under the agreement.
On April 27, 2009 Liberty registered their shares with the SEC. The author with an opposing view states that there is no way for Liberty to put a percentage on the registration statement. That is not the case at all. These forms allow footnotes that further explain the details of the transaction. In the Liberty filing the footnotes state, "1) The Convertible Perpetual Preferred Stock, Series B-1, has no expiration date, and is convertible into common stock at any time at a conversion rate of 206.9581409 shares of common stock for each share of Convertible Perpetual Preferred Stock, Series B-1." The company could have stated that the preferred converts to 40% of Sirius XM, but did not. The reason is that the conversion rate has now been established. Registering these shares does establish the voting rights, as well as determines what the stake is.
The author with the opposing view states, "Let’s see how Liberty shows the ownership levels of Sirius XM. If it is a share count, it would be listed as such on their filings. In fact it is not listed that way and is listed year in and year out as a flat 40% holding on their own filings further strengthening this position of being accurate. Here is in Liberty’s own words again. This is from their latest filing, their own 10Q form."
The author provides a screen shot of page I-16 on Liberty Media's 10Q and proceeds to explain that Liberty state that this is how Liberty "shows" their ownership level in Sirius XM. The Liberty stake is actually 39.56% of Sirius XM now, and the company simply rounded the figure up. Rather than offer a simple screen shot, I will provide investors with a link to the Liberty 10Q. How Liberty "shows" their interest is not the important issue. The important issue is how they "account" for their stake. Kindly refer to page I-18 of the provided link and you will note the following:
"Based on Liberty's voting rights and its conclusion that the SIRIUS XM Preferred Stock is insubstance common stock, Liberty accounts for its investment in the SIRIUS XM Preferred Stock using the equity method of accounting. Liberty has elected to record its share of earnings/losses for SIRIUS XM on a three-month lag due to timeliness considerations. As of December 31, 2010 SIRIUS XM had total assets and liabilities of $7,383 million and $7,175 million, respectively. SIRIUS XM's net income attributable to common shareholders was $43 million for the year ended December 31, 2010.
As of March 31, 2011, the SIRIUS XM Preferred Stock had a market value of $4,269 million based on the value of the common stock into which it is convertible."
The closing price of Sirius XM on March 31st was $1.65. Thus, 2,586,976,761 shares (if converted) * $1.65 = $4,268,511,655. This is the value that Liberty established. As you can see, the company rounded the actual value up to $4,269 million. You can do similar math on Liberty's other quarterly filings.
Clearly the issue remains confusing enough to some to warrant this additional attention and discussion. The importance of this issue is that we are only 9 months away from the standstill requirements of the Liberty deal that limit their ownership stake to 49.9%. Additionally, with Karmazin speaking of a potential share buyback, it becomes a reason some may want to invest in this company. Understanding the dynamics involved should be in the knowledge base of someone investing. They possible dynamics at play could impact an investors decisions. In particular what happens to your Sirius investment should Liberty take control.
In closing I will simply state that I have been writing about Sirius XM for several years, and following the company for even more. I do not shoot from the hip, and do not take writing about the company lightly. I research what I write about and take the time to contact multiple sources to vet out the facts of a story. I would stake my professional credibility on the fact that if Sirius XM buys back common stock without buying back preferred in tandem, that the Liberty ownership stake will increase.
Position - Long Sirius XM Radio, No Position Liberty Capital