libertymediaWhile most investors were surprised yesterday regarding the news that Liberty Media may not sell shares on a pro-rata basis.  I have been discussing this issue for a while now, as the concept was floated at a Liberty Media Investor presentation.  In my opinion Liberty will indeed not participate initially, and it has little or nothing to do with how they feel about the stock.  It is all about taxes, wash rules as it applies to a controlling entity, and getting above 50% on a diluted basis.

While Liberty Media has over 50% by SEC standards, they do not have above 50% by the standards that govern a Reverse Morris Trust.  The reason for this is that the shares tied to the 7% notes that SiriusXM just did a tender offer for and options shares are not calculated in the SEC standard, but are calculated in the RMT standard.  Simply stated, Liberty needs another 160 million to 200 million shares to be above the 50% level no matter which standard is used.

What does this mean?  It means that SiriusXM will likely buy back some 350 to 400 million shares before Liberty begins to participate.  It also means that it will take that much longer for Liberty to get back the $1.7 billion that it is seeking.  Of course, Liberty could simply buy shares on the open market, but that simply creates more high basis shares and makes the tax situation more muddy.  The wash rule as it would apply to Liberty needs to pass before Liberty sells anything.  Once that date passes Liberty can choose which lots of shares it want to sell.  They would obviously choose the highest cost basis shares first.

For Liberty, the position is good.  SiriusXM will buy back shares thereby increasing the Liberty stake.  In theory, the price of stock will rise, meaning Liberty has to sell less shares in order to recover the $1.7 billion.  That leaves Liberty with more high basis shares to sell back in future buyback programs.  Until the $1.7 billion is extracted and the high basis shares sold off, Liberty is essentially fully aligned with the common shareholder.  Things could get interesting (a couple of years from now) when Liberty gets ready to consider a spin.

In my opinion the strategies at hand are not really conducive to another dividend.  While the dividend will be beneficial to Liberty, it does not address the issue of getting rid of all of the high basis shares.  Certainly we may see one, but in my opinion it would simply prolong the time before a spin.

There you have it.  This is why Liberty may not participate initially.