Liberty’s Sirius Deal May Run Into Hurdles. Stock Prices Tell the Story.

Under the proposed combination, holders of the tracking stock, Liberty SiriusXM (tickers: LSXMK, LSXMA), would get 10.3 shares of Sirius XM (SIRI) stock for each Liberty SiriusXM share. Sirius XM would be re-christened as New Sirius XM as part of the transaction, which would be tax-free to Liberty Sirius XM holders.

The Liberty SiriusXM tracking stock was higher in the wake of the proposal, unveiled Tuesday morning, but trades well below the current value of the offer. That signals that Wall Street has its doubts that the deal will get done on the current terms.

The key issues are whether a special committee of Sirius XM Holdings formed to evaluate the proposal will back the deal, and whether the Internal Revenue Service will challenge the tax-free structure if an agreement is reached.

Liberty SiriusXM Class A shares were up 4.3% to $23.61 in afternoon trading, while Sirius XM shares had fallen 5.3% to $3.80. The
S&P 500
was about 1.3% lower.

 The current value of the Liberty Media offer is about $33.50 per Liberty SiriusXM share, meaning that at $23.61, the tracking stock trades at a roughly 30% discount to the value of the offer, Barron’s arithmetic indicates.

We calculated the value by taking the Sirius XM stock price and subtracting a payment of 55 cents in cash that Sirius XM holders would receive as part of the proposed deal. Barron’s multiplied the result, $3.25, by 10.3 to reflect the 10.3 shares of Sirius XM that Liberty SiriusXM holders would receive for each unit of the tracking stock.

The 30% discount to the value of the offer is very wide. Deals that are viewed as safe generally have so-called arbitrage spreads of closer to 5% or 10%.

Jeffrey Wlodarczak, an analyst at Pivotal Research Group, said he sees potential for gains in the Liberty SiriusXM tracking stock, given that gap. “They still need to reach a deal but in my view LSXMA/LSXMK stocks should be substantially higher,” he wrote to Barron’s in an email Tuesday.

He has a Buy rating and $41 price target on the Liberty SiriusXM tracking stocks.

Because the discount is so big, Liberty SiriusXM investors could still benefit if the tracking stock rose to reflect a deal struck on terms that are less favorable than the current proposal. The outcome is of interest to
Berkshire Hathaway
(BRK.A), which is the largest holder of Liberty SiriusXM with a stake of about 20% worth $1.5 billion. 

It hasn’t been a big winner for Berkshire. Both the tracker and Sirius XM stock have lagged badly behind the S&P 500 over the past five years. 

Sirius XM stock has fallen by about one-third over that period as growth has slowed. The company’s base of more than 34 million listeners is flat year over year and it skews older because many younger car buyers listen to music from their phones rather than paying $13.99 or more a month for satellite radio. Berkshire CEO Warren Buffett, 93, is a big fan of the Sirius service, favoring a station playing standards called Siriusly Sinatra.

Based on Barron’s conversation with investors, It is believed that the Berkshire stake was bought by investment manager Ted Weschler rather than by Buffett. Weschler, together with Todd Combs, runs about 10% of the $350 billion Berkshire equity portfolio.

The proposal from Liberty Media had long been awaited by holders. Liberty Media’s management, notably chairman John Malone and CEO Greg Maffei, had repeatedly telegraphed the transaction as a way to address a gap between the value of the tracking stock and shares of Sirius XM and to simplify the structure of the two entities.

The Liberty SiriusXM tracking stock has traded at an average discount to the value of its stake in Sirius XM of about 30% in recent years. It topped 50% in July, when a short squeeze drove Sirius XM briefly above $7 a share. The spread stood at more than 30% at the close of trading on Monday.

In August, Liberty Media paved the way for the current proposal by simplifying Liberty SiriusXM by creating a new tracking stock, called Liberty Live (LLYVK), for a stake in
Live Nation Entertainment
(LYV). This left the Liberty SiriusXM tracker with just the Sirius XM interest, some 3.2 billion shares, and about $2 billion of debt.

 As a tracker, the Liberty Sirius XM delivered to investors the economics of the underlying Sirius XM stake but not ownership of the stock.   

The special committee of Sirius XM may balk at the proposed deal, arguing that the Liberty SiriusXM tracking stock has long traded at a big discount to its SiriusXM stake, so any premium paid to Liberty SiriusXM should be based on the market price of the tracking stock and not its net asset value.

The argument would be that the true price of Sirius XM was that of the Liberty SiriusXM tracking stock, which is much larger and more liquid than the thinly traded public float in Sirius. 

At about $4 a share, Sirius XM trades for around nine times projected 2023 earnings before interest, taxes, depreciation and amortization, a premium to cable companies like
Comcast
and
Charter Communications,
which arguably have better businesses. Sirius’s growth in subscribers, revenue, and Ebitda have slowed this year. Sales were flat in the second quarter.

Given those factors, the relatively high valuation on Sirius XM stock would support the argument that the lower-priced tracking stock is the better indication of value.

“The NAV discount closure appears largely awarded to Liberty SiriusXM without much accommodation to public SiriusXM shareholders,” wrote Benchmark Research analyst Matthew Harrigan in a client note Tuesday. HIs view would support a tough position by the Sirius XM special committee.  

The proposal “rationalizes the dual corporate structure between LSXM and SiriusXM and provides value to all shareholders with a more flexible and attractive currency in New SiriusXM,” Maffei, the Liberty Media CEO, said in a news release. “SiriusXM minority shareholders will also benefit from enhanced trading dynamics, including increased liquidity and likelihood of future index inclusion.”

Liberty declined to comment beyond the press release.

The other issue is a complex tax question. Is Liberty Media’s 82% stake an actively traded business, which would be needed for the deal to be tax-free? Liberty has argued that it is, based on the way that it went over the 80% threshold in a transaction with Berkshire Hathaway in 2021.

New York tax expert Robert Willens wrote Tuesday that he and some others “have expressed some reservations with respect to this conclusion” based on prior transactions involving Sirius XM stock that lifted Liberty’s interest in the company.

“While Liberty normally secures private letter rulings (from the I.R.S.) for its transactions, that may not be the case here,” Willens wrote in an email to Barron’s. “Instead, Liberty might proceed with the split-off on the strength of counsel’s opinion. Of course, the I.R.S. is not bound by counsel’s opinion and would be free to challenge the deal on audit. 

“If it successfully proves that the split-off did not meet the active business requirement, both Liberty and the shareholders to whom the Splitco stock was distributed would be subject to tax. ….A “failing” spin-off or split-off is kind of a disaster since it creates two levels of tax, at both the distributing corporation and distributee shareholder levels.” 

Malone, who has a controlling stake in the tracking stock via supervoting shares, would give up the supervoting stake in the proposed deal. There will only be a single class of stock at Sirius XM if the Liberty offer goes through.

The Liberty proposal could prompt contentious negotiations with Sirius XM. But investors in the tracker could win if any deal is even remotely close to the current one.

Write to Andrew Bary at [email protected]