We all see headline after headline about Liberty Media saying that SiriusXM is under leveraged, or that Liberty Media wants to leverage the balance sheet. Sounds like a good thing on the face of it, but is it really good? That depends on your perspective. Essentially the words level and leverage are referring to debt. That is correct. The essential thing that Liberty is saying is that they want SIRI to take on more debt.
The first thing to grasp is that debt is not really always bad. What makes debt bad is when a company has difficulty servicing it. SiriusXM investors have always seen the company as having a lot of debt, and recently the company has been paying it down and refinancing it at lower and more attractive rates. SiriusXM actually has very little trouble servicing its debt.
This September 20th, SiriusXM will complete its recent announcement of paying down some $681 million in debt. It will bring the company down to about $2.4 billion on the books. The cost to service that debt will be about $185 million per year. As you can imagine, the company can easily pay that amount and still generate free cash flow.
What Liberty Media has stated in the past is that it wants to get the $1.5 billion it invested in SiriusXM common shares back. This can happen through share buybacks or dividends. More likely than not, it will be share buybacks. The problem is that SiriusXM will not have the cash to accomplish such a task. In order to buy back some 750 million shares, SiriusXM would need to double that amount. This translates to a share buyback on the order of 1.5 billion shares.
At $2.35 it would require $3.5 billion. The company does have cash on hand, and generates cash each month, so lets assume that they borrow $3 billion. That would put debt at $5.4 billion. The total cost to service that $3 billion in debt would be about $210 million per year. Add that to the $185 million that already exists, and you will have a company that is paying out almost $400 million per year to service debt.
That situation would change the dynamic of an investment is SiriusXM dramatically. More realistically, the company may take on $1.5 billion in debt. That would return the debt load to about 3.9 billion, and the cost to service debt would be a manageable $290 million per year, a level SiriusXM has lived with in the past. At a debt load of $4.4 billion the interest expense would be about $320 million per year.
If we model this, we can begin to get an idea of how such activities would impact SiriusXM. In developing a model we have to carry certain assumptions. First, I will assume that the company will maintain about $500 million in cash on the balance sheet. The remainder of cash will be used to continue share buybacks. Under a debt load of $3.9 billion, the initial $1.5 billion, used to retire shares should retire about 630 million shares from the count. Cash could retire another 170 million. That would bring the fully diluted count from 6.8 billion to about 6 billion. If we take out an additional $500 million in debt to buyback shares we would retire another 213 million shares, bringing the total count down to 5.77 billion. Now let's model the impacts to EPS:
There are a few points of clarity here. You will notice that I have included the tax liability on the EPS. The company will not really pay this tax, but because of how they booked the NOL's this year, going forward they will always have to show the tax liability as if it were being paid. This will be a "drain" on EPS. You likely will not see this information from other sources, but as a SiriusBuzz Premium member, you are now aware that the tax line will drain EPS from Q1 2013 onward. As you can see, the company can add debt and buy back shares, and the needle on EPS will not really move substantially. As buybacks continue, the needle will move more, but after the initial debt loading, share buybacks will need to come from cash.
Realistically speaking a company like SiriusXM is not valued on EPS. Now lets take a look at EV/EBITDA multiples and see what we arrive at:
The first thing to bear in mind is it is EBITDA and FCF that are typically used to value a media company like SiriusXM. In these models you can see that to arrive at similar valuation multiples the price of the stock could be as high as $3.15. I know for some it seems odd that the stock price is higher with more debt, but that is how things work. As long as the company can service the debt, there are no real issues.
Should Liberty wanting to level SiriusXM scare you? Not necessarily. It all depends on how much debt they want to load on.