Buy Liberty SiriusXM As It Merges With Sirius XM For 50% Near-Term Upside

Liberty SiriusXM and SiriusXM comply with merge

As extensively anticipated (and for a lot too lengthy), The Liberty SiriusXM Group (NASDAQ:LSXMA) (NASDAQ:LSXMK) (NASDAQ:LSXMB) and Sirius XM Holdings Inc. (NASDAQ:SIRI) have lastly agreed to merge. This implies about 9 months from now Liberty SiriusXM shareholders will obtain roughly 8.4 shares of the brand new SiriusXM, thus proudly owning a complete of about 81% of the brand new firm, whereas the present minority shareholders of Sirius XM Holdings will personal the remaining 19%.

The transaction is predicted to be tax-free, and there are not any potential obstacles to its approval, on condition that Liberty already owns 84% of SiriusXM and successfully controls the corporate. Minority shareholders of SiriusXM gained’t vote on the deal, whereas Liberty Media’s shareholders will – however there can’t be any doubt how John Malone along with his super-voting B-shares, alongside giant house owners like Berkshire Hathaway (BRK.B) (BRK.A) and Seth Klarman, will determine: Liberty SiriusXM trades for lower than 70% of its underlying worth, which implies that collapsing the low cost is probably the most accretive factor to do.

The 81/19 possession cut up is the results of a months-long bargaining progress, originally of which stood Liberty’s proposal to compensate SiriusXM minorities for the extra debt assumed in a merger through a money dividend. This answer was not adopted, as it might have burdened SiriusXM with much more debt. As a substitute, Liberty will hand over about 3% of its possession curiosity in trade for minorities assuming extra debt.

You possibly can evaluation all the main points in at the moment’s slide set.

However the NAV low cost doesn’t shut

What’s most attention-grabbing about this deal is that, as I write, there stays an enormous discrepancy between the intrinsic worth of the Liberty SiriusXM monitoring shares and their buying and selling value. As of now, the trackers commerce for about $27, whereas 8.4x Sirius XM’s value of $4.8 would lead to a worth of greater than $40.

So what’s mistaken right here? Is the market simply nuts?

For a very long time, there was that concept on the market about SIRI being the overvalued inventory of the pair, given its huge share repurchases and low liquidity. As a substitute, the LSXM trackers would have been the pretty and effectively valued shares. I personally doubt that idea, however that is what some buyers have been saying. At present, it actually appears to be like like no person needs to bid up the monitoring shares, whereas SIRI even traded decrease after the announcement (after being up 10% yesterday).

It would rally a couple of minutes from now – who is aware of? At the very least that is what SIRI has represented over the previous few months: a textbook instance of stomach-turning volatility.

Why the NAV low cost stays elevated

My private rationalization for the phenomenon is quite short-termism: Given the small buying and selling float of SiriusXM inventory, coupled with an outsized brief curiosity (which might be not primarily as a consequence of an assumed overvaluation, however merely to the numerous arbitrageurs on the market that needed to wager on the closing of Liberty’s buying and selling low cost by going lengthy LSXM and shorting SIRI), the inventory market has been extraordinarily inefficient for SIRI shareholders for a very long time. Frequent brutal selloffs have been adopted by huge brief squeezes.

Therefore, till LSXM shareholders lastly get their arms on their SIRI inventory and the float will increase, there will likely be a whole lot of volatility. Technical points and provide/demand imbalances may have big impacts, just a few of which have been examined in my latest article on the scenario.

The inventory market will begin to value within the trade ratio of 8.4x between the 2 courses of inventory of the identical firm over the following few months, and when SIRI suffers from certainly one of its low-float selloffs, LSXM trackers will most likely endure as effectively. Or not, who is aware of?

In a nutshell: For anyone searching for short-term outcomes, that is no engaging scenario, until we’re speaking about ultra-short-term, super-speculative buying and selling. In case you personal shares just for minutes, quick movers are nice.

Cut price alert for worth buyers

Lengthy-term oriented of us might want to fasten their seat belts. Within the meantime, it ought to assist to have a transparent view of what they successfully personal: a bit of SiriusXM.

Every share of the Liberty trackers (the Ok, A and B shares from at the moment will yield precisely the identical end result, as they’ll handled as a single class of shares) provides its shareholder a declare on the earnings belonging to eight.4 shares of the brand new SiriusXM, which can seemingly earn $1.5B of free money movement, or FCF, inside just a few years (as soon as the present huge funding section in new satellites will likely be executed) and have 3.4B shares excellent, so the FCF belonging to every share of the LSXM trackers will likely be $3.70 in 2025 or 2026.

Even when FCF stagnated on the present stage (unlikely, since it’s closely depressed by this 12 months’s further investments to the tune of ~$300m), FCF per present LSXM tracker would nonetheless be round $3. This implies the trackers have a present 11% look-through FCF yield, which is prone to improve over the following few years.

From a purely elementary perspective, this appears to be like fairly engaging to me, and I actually gained’t promote a single share at these ranges and gained’t offload my SIRI inventory as soon as acquired so long as it continues to hold an 11% FCF yield.

Nonetheless, not many fund managers can personal such unstable shares, the place principally something can occur day by day. So, the present low cost appears a “volatility low cost” to me, unrelated to enterprise fundamentals.

The speculation {that a} inventory like SIRI with its tiny buying and selling float can nonetheless be overvalued whereas having a lot of its float offered brief sounds implausible to me. Why would SIRI keep stubbornly overvalued whereas everyone is aware of that it ought to fall some 20-30% inside just a few months and whereas it’s attracting brief sellers because of the LSXM/SIRI arbitrage commerce?

And even when there was some strain on the inventory near its merger or proper afterwards (LSXM shareholders would possibly promote their new SIRI inventory immediately), the very seemingly index inclusion of this $19B firm with the ensuing shopping for spree by index funds ought to compensate for that.

In case you can abdomen the volatility, you’ll most likely be richly compensated. I consider the brand new SIRI shares will settle round a extra frequent FCF yield of about 7%, i.e., they need to commerce for about $43 – and develop from there, as decrease capex ranges kick in and FCF grows over the following years.

This implies present LSXM holders can count on a return of about 50-60% inside one 12 months.

Dangers are virtually negligible

The draw back is fairly negligible, in my opinion. Even at SIRI’s latest multi-year lows of about $3.50, the underlying worth of the LSXM trackers would nonetheless be $29.40, i.e., about 9% larger than at the moment’s buying and selling value. At that time, the inventory would commerce for a look-through FCF yield north of 10%.

That stated, some readers will query my FCF estimates: Why ought to FCF develop? In any case, SiriusXM loved a particularly low tax fee till just lately however has now develop into a full taxpayer. Nonetheless, the corporate is seeking to decrease its tax fee and can quickly provide you with some tax optimization, because it acknowledged at a latest convention:

And as we glance forward, we actually hope that there will be some alternatives to scale back taxes and we’ve got some ideas on that, that we’re not able to share but, however I do assume there will be some enhancements in our tax profile going ahead as effectively.

Furthermore, regardless of giving often quite conservative steerage, the corporate sounded very assured in having the ability to develop FCF going ahead:

I believe as we glance past subsequent 12 months, as a result of we nonetheless have form of satellite tv for pc CapEx at a excessive stage, and non-satellite upkeep ranges for the brand new platform at a fairly excessive stage. As you look past to ’25 and ahead, we might count on free money movement to develop, and over the following 5 years for positive.

I consider administration on this respect since 2023 noticed a $200m capex improve for brand spanking new satellites (which I take into account a progress funding) and a $100m improve in music royalties (which SiriusXM can often get well by elevating subscription charges, albeit with a lag), alongside different smaller investments. The corporate acknowledged on its This fall/22 name that satellite tv for pc capex will reasonable already in late 2024 and shrink to close zero in 2027, the place it’ll keep for a few years.

In Q3/23 SiriusXM guided to $1.15B of FCF for 2023. Excluding 75% of the satellite tv for pc capex and the one-off improve in music royalties, its steady-state capex needs to be roughly $250m decrease, which suggests it wants little or no progress to ship the $1.5B of FCF which I count on in 2025 or 2026 on the newest.

In abstract, if SiriusXM trades for an affordable FCF a number of for a slowly rising subscription enterprise with enviable belongings, Liberty shareholders will do nice in a really brief timeframe. And even when SIRI slumps, Liberty shareholders would nonetheless not lose a lot and even acquire a little bit.

And even when I’m lacking one thing, I actually am not lacking one security backstop: In addition to serving a sexy, quite prosperous buyer inhabitants, SiriusXM owns a bit of unique actual property in 80% (and rising) of all U.S. vehicles on the street with the chance to obtain audio and video through its personal satellites – how may that not be a sexy acquisition goal for a tech enterprise looking for to broaden into vehicles?

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