Description

Liberty SiriusXM (LSXMA) is value hiding in plain sight.  Liberty Media's investment in Sirius XM Holdings' publicly-traded easy-to-value common stock represents over 97% of LSXMA's asset value, yet LSXMA currently trades at a 27% discount to NAV.  While this discount has persisted for several years, history shows that, sooner or later, Liberty eliminates its tracking stock discounts.  With SIRI itself trading slightly off its 52 week lows, LSXMA presents an attractive investment opportunity.

LIBERTY SIRIUSXM.

Liberty SiriusXM is one of three tracking stocks issued by Liberty Media Corporation, the three trackers being Liberty SiriusXM, Liberty Braves, and Liberty Formula One.  The Liberty SiriusXM Group tracks the financial performance of Liberty Media's investment in Sirius XM Holdings.  The Liberty Braves Group tracks the financial performance of the Atlanta Braves major league baseball club and its stadium and adjacent mixed use real estate development.  Liberty Media attributes to the Liberty Formula One Group all its other businesses, assets, and liabilities, including Liberty's interests in Formula One and Live Nation Entertainment, and various and sundry minority equity investments.

Liberty Media is controlled by its Chairman, John Malone, and is managed by Malone and its chief executive, Greg Maffei (who joined the company in 2005).  Management's track record of value-enhancing transactions has been exceptional, including the profitable acquisition and subsequent split-off of DirecTV, rescue financing for Sirius XM Holdings in the depths of the financial crisis, and a timely investment in Charter Communications.

Liberty SiriusXM Group has three classes of common stock:  Series A (LSXMA), with one vote per share; Series B super-voting shares, with ten votes per share; and Series C (LSXMK), with no votes per share.  All series of common stock participate on an equal basis with respect to dividends and distributions.  LSXMA and LSXMK both trade freely, but LSXMK is more liquid and currently trades at a slight premium.  John Malone owns approximately 96% of the Series B shares for each of the three tracking stocks and controls approximately 48% of the voting power of Liberty Media.

Liberty Media owns over 68% of Sirius XM Holdings' common stock; as previously noted, this investment is attributed to the Liberty SiriusXM tracking stock and represents 97% of the tracker's asset value.  Also attributed to Liberty SiriusXM are (1) Liberty's investment in iHeart Media debt securities, and (2) debt with a current principal balance of $1.2 billion ($400 million of 2.125% exchangeable senior debentures due 2048 and $800 million in margin loan obligations secured by Sirius XM Holdings shares).

SIRIUS XM HOLDINGS.

Sirius XM Holdings (SIRI) was created by the merger of Sirius Satellite Radio with XM Satellite Radio in 2008.  By early 2009, SIRI was at bankruptcy’s door.  In February 2009, in a transaction that allowed SIRI to repay its near-term debt maturities and thereby avoid bankruptcy, Liberty Media (1) loaned SIRI $411 million (including participations), all of which was repaid in 2009, (2) committed to loan SIRI another $150 million, which commitment was cancelled in 2009, and (3) paid $12,500 for voting preferred stock convertible into 40% of SIRI's common equity.  Liberty ultimately exercised the conversion option, and the common stock into which it was converted has a current market value of approximately $17 billion.

SIRI operates a satellite radio service transmitting commercial-free music channels, and sports, entertainment, comedy, talk, news, traffic, and weather channels, in the United States on a subscription fee basis.  Satellite radios are distributed primarily through automakers.  Subscribers can also stream music and other channels over SIRI's internet radio service.  Subscription fees represent SIRI's primary source of revenue.  SIRI also derives revenue from advertising on select non-music channels.  SIRI has over 34 million subscribers.

SIRI also holds a 70% equity interest and 33% voting interest in Sirius XM Canada (Sirius XM Canada's subscribers and financial results are not included in SIRI's consolidated numbers).

On February 1, 2019, SIRI acquired Pandora Media, Inc. in an all-stock transaction valued at approximately $3.5 billion (valued at the time the deal was announced).  Since acquiring Pandora, SIRI has repurchased approximately 2/3 of the stock issued for the acquisition.  Pandora is available as a streaming ad-supported radio service, a streaming radio subscription service (Pandora Plus), and streaming on-demand subscription service (Pandora Premium).  The majority of Pandora's revenue is generated from advertising on its streaming ad-supported radio service.  Pandora has approximately 6.9 million subscribers and approximately 66 million active users.

Since Liberty's rescue financing, SIRI's financial and business performance has been exceptional.  Consistently adding subscribers and instituting periodic price increases while controlling content and SG&A costs has yielded consistent increases in EBITDA.  Limited capital expenditure requirements (capital intensity of approximately 3.5%, increasing to just under 5% during periodic satellite replacement cycles) and no material cash taxes due to large NOLs leads to outstanding free cash flow conversion.  In short, SIRI has been a free cash flow machine.

Unfortunately, past is not entirely prologue, and I expect SIRI to experience slowing growth in coming years.  In a April 25, 2017 write-up, Flaum recommended shorting SIRI.  Since Flaum's write-up, SIRI's EBITDA increased by 19%, SIRI acquired Pandora, and SIRI's share count declined by 2%, notwithstanding the stock issued to purchase Pandora.  Nonetheless, many of the challenges described by Flaum are legitimate, and I encourage readers to review the write-up.  However, I believe SIRI will continue to increase EBITDA over the coming years notwithstanding these challenges.

• SIRI should add subscribers for the foreseeable future, albeit at a slower rate.  SIRI is increasing penetration in new vehicles (e.g., SIRI radios will become standard equipment in all Toyotas beginning next year).  Penetration in the used car fleet is also increasing and SIRI should continue to add subscribers through this channel as well.

• SIRI has demonstrated pricing power, raising prices several times with no material effect on churn, most recently passing through the increased music royalty rate imposed at the end of 2017.  Thus, even with reduced subscriber growth, SIRI should still be able to drive revenue growth.

• Comparison to cable television distributors is instructive – notwithstanding cord cutting and an ongoing decline in video subscribers, video revenues have generally continued to increase due to higher pricing.  (Video profitability is another story, due to spiraling content costs, an issue not faced by SIRI – see next bullet point.)

• SIRI's content costs are well controlled.  Non-royalty content costs are generally in the range of 6% of revenues.  And while the music royalty rate paid by SIRI increased substantially at the end of 2017 (to 15%), the rate is now fixed until 2027.

• Pandora provides another avenue for revenue growth, especially advertising revenue.

VALUATION.

Several return scenarios are presented below, showing the hypothetical returns to an investment in LSXMA if the NAV discount is eliminated at the end of 2021 or at the end of 2024.  Specifically, for 2021 and 2024, three scenarios are presented:  (1) projected returns if SIRI's stock price remains flat for the entire period; (2) projected returns if SIRI's stock is valued at 10x EBITDA; and (3) projected returns if SIRI's stock is valued at 12x EBITDA.  SIRI currently trades at 14x 2019 estimated EBITDA; thus all scenarios contemplate multiple compression.

SIRI Assumptions.

• SIRI begins paying cash taxes in 2021 and is a full cash tax payer beginning in 2022.

• Satellite cap-ex tapers to zero by the of 2019 and restarts in 2023.

• Cash taxes and satellite cap-ex result in free cash flow in 2024 being no greater than free cash flow in 2021; however, free cash flow per share is materially higher in 2024.

• SIRI maintains gross leverage of 3.5x EBITDA, and maintains a cash cushion of $500 million.

• Free cash flow, plus increased borrowings from maintaining leverage at 3.5x, is devoted to share repurchases.

• The price at which shares are repurchased is assumed to increase by 10% per year (thus, the repurchase price for most years under all three scenarios is higher than the exit price).

• SIRI's equity-accounted investment in Sirius XM Canada is valued at book value.

LSXMA Assumptions.

• LSXMA's NAV is calculated on a pre-tax basis.  Liberty has multiple avenues to collapse the NAV discount on a tax-deferred basis and, given Liberty's history, the chance of Liberty undertaking a taxable transaction to eliminate the discount is close to zero.

• The value shown for Liberty's iHeart Media investment is the fair value at March 31, 2019 of $660 million of iHeart Media bonds held by Liberty.  iHeart Media emerged from bankruptcy on May 1, 2019.  Pursuant to the plan of reorganization, Liberty's $660 million of bonds were exchanged for newly issued common stock (which Liberty has sold) and newly issued debt securities (which Liberty continues to hold).  I believe that the March 31, 2019 fair value amount is a reasonable approximation of the current value of (1) the cash received by Liberty on its sale of iHeart common stock plus (2) the newly issued debt securities held by Liberty.

• Free cash flow (dividend income less G&A costs and cash interest costs) is devoted to share repurchases.  I do not model Liberty financing repurchases through increased debt, although depending on the size and persistence of the NAV discount, I believe that remains a possibility.  By my math, LSXMA is generating zero attributed taxable income; thus, I model no cash taxes.

• The price at which shares are repurchased is assumed to increase by 10% per year.  This, as with the similar assumption made for SIRI repurchases, is arbitrary.

NOTE:  All dollar amounts are US$ millions, except per-share amounts.

Return Scenarios.

Spectrum.

The foregoing analysis assigns no value to SIRI's spectrum.  Sirius XM Holdings was created by the merger of Sirius Satellite Radio with XM Satellite Radio in 2008.  Since the merger, SIRI has essentially been running dual systems to accommodate legacy Sirius equipment and legacy XM equipment.  Shortly after the merger, SIRI began transitioning its legacy Sirius OEM automakers from the Sirius chipset to the XM chipset.  However, things move slowly in auto-land; the last of legacy Sirius OEM automakers will be off the Sirius platform by next year (i.e., all new installs from all major automakers will be the XM chipset beginning next year).  Nonetheless, there will be a substantial number of late model cars with the Sirius chipset for several years after 2020; consequently, SIRI will continue to support the Sirius chipset for several years after 2020.  Management has said that by 2023 at the earliest and 2025 at the latest, it will be feasible to transition legacy Sirius radios to the XM chipset with an equipment solution.  Once radios are transitioned to the XM chipset, the Sirius spectrum will be freed up for other uses.  Management has been open-ended on the possible use (or sale) of the spectrum, but it is reasonable to assume it will be utilized for financial gain.

RISKS.

Recession/Slowing Auto Sales.  SIRI has been the beneficiary of a long-lasting tailwind of robust new car sales.  Slowing of new car sales, whether caused a recession or otherwise, will negatively affect SIRI's subscriber growth.

Competition.  Increased competition for listening time within cars, e.g., Spotify/Apple Music.

Tracking Stock.  Holders of Liberty SiriusXM common stock are common stockholders of Liberty Media Corporation, i.e., the company as a whole.  Holders of Liberty SiriusXM common stock have no legal rights related to the specific assets attributed to the Liberty SiriusXM Group and, in any liquidation, holders of Liberty SiriusXM common stock will be entitled to receive a pro rata share of Liberty Media Corporation’s available net assets together with the holders of Liberty Braves Group Shares and Liberty Formula One Group shares.  The assets attributed to the Liberty SiriusXM Group are potentially subject to the liabilities attributed to another tracking stock group; i.e., creditors are not precluded by the tracking stock structure from proceeding against any assets they could have proceeded against if Liberty did not have a tracking stock structure.

In addition, Liberty management has the authority to, without shareholder approval, reattribute assets among the trackers, and to collapse the tracker structure.  There have been occasions in the past where Liberty tracking stock reattributions have caused angst among part of the shareholder base.  Nonetheless, Liberty has utilized tracking stocks many times over its corporate life, and history shows that shareholders have generally been treated well.  Liberty is not Dell.

Catalyst

Liberty Media corporate action to eliminate the tracking stock discount.