Description

Trade Idea: Long LSXMK / Short SIRI

Summary

Liberty SiriusXM (“LSXM”) is a tracking stock that tracks Liberty Media’s stake in SIRI (69% of SIRI S/O) along with some cash, debt, and a tiny amount of other assets. The tracking stock discount to NAV has widened from a historical average of 16% before 2018 to 31% most recently. The exact reasons for the widening discount are unclear, though it may have something to do with 1) the blowup of the DVMT spread in late January 2018, 2) the meaningful increase in SIRI’s share price in 1H18 (with LSXM lagging this trend), 3) the increased borrow cost for SIRI before the P deal closed. Additionally, LSXM has a far larger float vs. SIRI and SIRI has been buying a lot more of its own stock than LSXM, which might have exacerbated the discount. I think the discount for LSXM is unwarranted considering the simplicity of the tracker, management’s stellar reputation in capital allocation and strong desire to eliminate the discount, and significant insider ownership of the tracking stock.

Investment Merits

Strong Track Record of Eliminating Discounts and Shareholder Friendliness: Liberty management is aware of the large LSXM discount and has publicly stated their desire to eliminate it on multiple occasions. Liberty issued $400mm of debt in January 2018 to finance a potential purchase of iHeart, however, in February 2018 as the iHeart acquisition became less likely and the LSXM discount widened, management shifted its focus away from iHeart, and instead started buying back LSXM stock at an annualized rate of 3-4% of market cap. I think the pace is much too slow to have a real impact on the discount, but at least it indicates management’s willingness to eliminate it. Based on Liberty’s track record dealing with similar discounts over the past ~20 years (not included in this write-up), I think it is highly likely the company is waiting for the right moment to execute a “creative” structure to close the discount in its entirety. I don’t know what this structure will look like since this situation is different than past transactions but believe that Liberty will seek to maximize value over time. Below some of the management commentary on the discount:

• “[W]e do things that we think are logical instead. And if the market wants to give us this stock at a discount, we're going to continue to buy it back and take advantage of it. You may note that SIRI bought less back of their own, and we bought more back here. It speaks to something about what is the combination of their stock price and our discount. So we'll see.”
• “If the great people want to give that stock at a discount, we're likely to continue to take advantage of it. And we have been sometimes clever in finding ways to take advantage of it in better ways, like the GCI transaction.”
• Analyst asked on earnings call whether LSXM would raise more debt than the $400mm notes to buyback shares: “But there's a limit as to how much leverage we can put at [Liberty SiriusXM]. So -- but we'll consider that and we always have other means to surprise people and eliminate the discount.”

Strong Shareholder / Management Interests Alignment: LSXM has three series of stock with different voting characteristics: Series A (LSXMA) has one vote per share, Series B (LSXMB) has ten votes per share and is owned almost exclusively by John Malone, and Series C (LSXMK) has no voting power. The large insider ownership of the non-voting LSXM share classes gives comfort that our interests are strongly aligned with management.  Below are the shares owned by John Malone and Greg Maffei (CEO):

• John Malone: $46mm of Series A, $349mm of Series B (second largest personal public holding), $606mm of Series C (largest personal public holding). Collectively, Malone owns ~8% of LSXM.
• Greg Maffei: $71mm of Series A (third largest personal public holding), $119mm of Series C (second largest personal public holding).

What Could Go Wrong

Asset Re-attribution: Based on the tracking stock agreement, Liberty has the ability to re-attribute assets between tracking stocks. Other than LSXM, the other two tracking stocks managed by Liberty are: 1) Liberty Braves, which tracks Liberty’s ownership of the Atlanta Braves (private company) and 2) Liberty Formula One which is comprised of the Formula One Group along with a number of other, mostly public, holdings. Re-attributing assets to/from LSXM could either make Liberty SiriusXM a more complicated security (i.e. make it look more like a multi-asset holdco), or the terms of the re-attribution might be a net negative for the tracking stock, which could hurt the spread further. Liberty has done four re-attributions between tracking stocks in the past (involving eight trackers, two in each of the four re-attributions), with the goal of simplifying a tracking stock, taking advantage of tax assets or optimizing its capital structure. The re-attributions were viewed positively by the market for seven of the eight trackers.

Buying SIRI with LSXM Equity: Liberty currently owns 68% of SIRI and Liberty CEO, Greg Maffei, has been outspoken about wanting to own all of SIRI. The risk of this proposition is that Liberty SiriusXM could use their undervalued equity to buyout the SIRI minorities at a premium. Given the stellar track record of capital allocation, moves to mitigate the discount, and high insider ownership of LSXM by Maffei and Malone, I think this is unlikely. Also, though I don’t like to take management commentary/promises to the bank, Liberty has been quite explicit in this regard:

• “But if you look objectively, if people think that Liberty management is likely to utilize the LSXM currency in some way to overpay for [SIRI] or anything else, it's just not in our history and I would not bet that that's what's going to happen. Now there may be movements over time, but I would bet that, that tightens in the end. So if you ride with us, if you have the ability to ride with us, I think that's a pretty attractive security.”

SIRI Borrow Cost: If SIRI continues buying back its stock (which it plans on doing), the increasingly limited float could make borrowing SIRI shares more expensive, which hinders the arbitrage IRR. Currently SIRI cost of borrow is GC.

Valuation

In my base case I assume LSXM trades back to its pre-2018 average of ~84% of NAV, resulting in 21% upside. My bull case assumes Liberty does something creative to completely close the discount, resulting in 44% upside.

Catalyst

Eliminating the discount through a "creative" structure

Continued share repurchases