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Keep the Change, Sirius XM

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You know that Sirius XM Radio (Nasdaq: SIRI  ) has come a long way when analysts start treating it like some candy-filled pinata.

The very first analyst question raised during the satellite radio provider's conference call yesterday enquired whether the company's focus on returning capital to its investors would take the form of share repurchases or the institution of a dividend.

A dividend? Sirius XM? Really?

To be fair, the company brought that expectation on itself.

"It's free cash flow that enables you to pay down debt, make acquisitions, or return capital to shareholders," CEO Mel Karmazin pointed out earlier during his prepared remarks.

After generating $185 million in free cash flow during a volatile 2009, and $210 million during a resurgent 2010, Sirius XM is targeting free cash flow to approach $300 million this year. If Karmazin is serious about focusing on reducing the company's debt load, snapping up other companies, or returning capital to its investors, his flexibility to do so is thankfully growing.

I just hope this doesn't come to a dividend.

Money is a monster
Sirius XM has been able to extinguish some of its debt lately. It's made no major acquisitions, more from a lack of opportunities than desire on that front.

This brings us to returning capital to Sirius XM's shareowners, and here's where things get dicey.

Liberty Capital (Nasdaq: LCAPA  ) owns a preferred stake in the company, convertible at any point to 40% of the common shares outstanding. Liberty Capital's been in no hurry to make the swap. Every time that Sirius XM issues stock to its employees or trades debt for equity, Liberty Capital cracks a smile. It will be getting 40% of those new shares, since its preferred shares can't be diluted.

However, things may get tricky if Sirius XM instead begins to eat away at its gargantuan share count. There are nearly 6.5 billion fully diluted shares once you bake in Liberty Capital's stake. Can Sirius XM go all Pac-Man on its float if doing so eats into Liberty Capital's 40% stake? If it doesn't, Sirius XM could be risking its $8 billion in net operating losses, if repurchases result in granting too large an ownership stake to Liberty Capital. Sirius XM would have to wait until next spring -- three years after Liberty's initial position triggered an ownership change -- to go that route and still protect its juicy tax-loss carry-forwards.

In short, buybacks aren't worth the hassle.

This naturally leads us to the initiation of a payout policy, but that doesn't make a whole lot of sense, either.

Sirius XM still has nearly 6.5 billion fully diluted shares to rain coppers on. Let's say that Sirius XM goes with the bailed-out-bank token minimum of $0.01 a share every quarter. The stock may find some support in this low-interest rate environment yielding a little more than 2%, but what would happen to Sirius XM itself?

Paying out $0.01 a share every three months does amount to less than the $0.03 a share that analysts see Sirius XM earning this year. But more importantly, $260 million in distributions would nearly devour the company's projected free cash flow this year.

Future years will get better. Sirius XM is coasting these days, and free cash flow will continue to grow as long as the model's still working.

What's the point, though? Shareholders aren't buying into Sirius XM for today's cash flow. They don't need the taxable event of a dividend.

Let's go shopping
If Sirius XM won't use its growing cash flows to beef up its R&D or broker deals to wedge its way into more gadgetry, its best bet is to begin gobbling up tactical acquisitions.

The key here is that the purchases have to be profitable. Sirius XM is in a position to offset $8 billion in pre-tax profits in the future. It may as well milk that.

In other words, forget Sirius XM making a bid on money-losing labels EMI and Warner Music Group (NYSE: WMG  ) , both currently on the block. Such moves might help it make back some of the money it's shelling out in music royalties, but the labels are anchors in quicksand. They're just not worth the hassle.

Regulators would never let Sirius XM buy Pandora, but even smaller music-discovery websites would be a mistake. If popular Pandora is losing money, just imagine how bad things must be for Slacker or

If there were a way to exploit TiVo's (Nasdaq: TIVO  ) Time Warp patents on radio, perhaps Sirius XM might consider buying it out. But TiVo wouldn't be limiting its legal eagles to feast on cable providers if that were the case. Besides, TiVo has posted losses for eight quarters in a row.

However, digital audio technology isn't too far a reach from Sirius XM's turf. It's also a field ripe with earnings-accretive opportunities. DTS (Nasdaq: DTSI  ) is very profitable, but too rich for Sirius XM's blood -- unless it were willing to take stock in a transaction. SRS Labs (Nasdaq: SRSL  ) is more affordable and also very profitable, but would it be enough to move the needle?

There's always content. Sirius XM could buy Martha Stewart Living Omnimedia (NYSE: MSO  ) for less than this year's free cash flow. Stewart isn't as big a draw as Sirius XM peers Howard Stern or Oprah Winfrey, but at least her entire empire's available at a reasonable price. Either way, Sirius XM is better off buying profitable talk content than going after its money-losing providers of music. 

Back to debt
At the end of the day, maybe just getting back to nibbling away at its debt, the way it did in its most recent quarter, is Sirius's best way to go with that free cash flow. Doing so isn't really necessary; the company doesn't have any major repayment milestones coming up soon, and its perpetually improving fiscal performance will generate healthier leverage ratios.

However, at least it's one way to retire the demons that almost destroyed the company two years ago.

Keep the money you're making, Sirius XM. You earned it, and you just never know when you'll need it.

What do you think Sirius XM should do with its growing free cash flow? Share your thoughts in the comment box below.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz is a subscriber to both Sirius and XM. He does not own shares in any of the companies in this story. He is also a member of the Rule Breakers analytical team, seeking out the next great growth stock early in its defiance. The Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 16, 2011, at 4:33 PM, EEasyMoney wrote:

    What should Sirius XM do with its growing free cash flow?

    Buy up shares of LCAPA. It would be the guppy taking a bite of the whale, but it might make sense. SIRI is no longer a guppy, and Malone's company has a lot of control over SIRI's future. Why not buy back some of that control? LCAPA owns 40% of the company, but SIRI has bigger market cap than LCAPA, quite different than the situation two years ago.

  • Report this Comment On February 16, 2011, at 4:44 PM, Austin77478 wrote:

    For the long term investors, Sirius’ paying down debt would be good for the stock price. Sirius should keep paying down debt. Rick thank you for the article.

  • Report this Comment On February 16, 2011, at 4:47 PM, ThongLover854 wrote:

    In my opinion, there is only one way they should go with their upcoming FCF...debt reduction. $3 Billion in debt is HUGE. The author mentions it's not necessary as they don't have any looming debt towers, but the debt coming in a couple of years is no small change. Sitting on the money for 1.5 to 2 years is the best bet in my mind. That way in 2013, they can drop $500-$750 million towards debt and make a huge dent in the outstanding debt.

    Then, going forward, FCF in 2013-2015 will most likely be $500 million to $1 Billion...the rest of the debt should be payed off by 2015-2016 in my opinion. By that time, Sirius will have increased their pricing by 10-20% due to new added services and they will have 25-30 million subs.

    I can't imagine SIRI stock being worth less that $8-$10 by that time. The next 3-5 years this stock is gonna keep on trucking towards double digits.

    Long SIRI...

  • Report this Comment On February 16, 2011, at 4:48 PM, SiriusXMlifer wrote:

    Please put that cash into R&D! Get ahead of the curve and stop playing catch up when it comes to technology!

  • Report this Comment On February 16, 2011, at 5:29 PM, doubting wrote:

    Karmazin was unusually straightforward during the CC that the company is more likely to buy back shares then pay dividends or make any acquisitions. He also made it clear that if the buyback happens, it will be with the float rather than from Liberty's 40% stake. Karmazin will certainly invest in research but the numbers may be in tens of millions, which is change at that time. He is happy with debt at EBIDTAx3 that will make debt at about $2.2B. This means siri will pay off any debt due before 2015 and will most likely refinance 2015 and may be even 2018 debt if the rates are better than now. Siri will be credit worthy at that time. I share his opinion that share buybacks will move the stock the fastest. Karmazin's credo is strong fcf. With potential price increase in 2011, siri will most likely be generating between $$ 1.5 - 2BB fcf by 2015. As I said earlier, the stock is as solid as a rock. We should expect another credit upgrade by S&P and Moody's that may move the stock well over $2. The way I see it is that the market is waiting for any good news before the next CC to move the stock above two bucks. It is quite possible that this may happen on mere further analyst upgrades without any great news. You can imagine what will happen after the price increase in the second half of 2011. Karmazin was quite clear about that. Shares buyback and price increase were the two pieces of news I was craving for. That is what will make siri market darling again as in 2004. Fortunately for shareholders, this time it is going to be on real merit. Some hype will not hurt either. .

  • Report this Comment On February 16, 2011, at 6:09 PM, GNLmgmt wrote:

    Hello? SIRIdoom? Why are you hiding?

  • Report this Comment On February 16, 2011, at 6:24 PM, multi007 wrote:

    I dont worry about the looming debt coming due in a few years - i think they'll re-up the debt for another term anyway - especially if rates stay low. Paying down debt is good, paying off the baloon might not be.

    Please dear God - do not buy MSO! Its an aging limited brand and once the queen passes away, the stock will go the way of George - the magazine that died shortly after JFK Jr did.

    I recommend (and i believe they already do) invest in R & D.

    long siri..

  • Report this Comment On February 16, 2011, at 7:23 PM, my2cents4u wrote:

    "Regulators would never let Sirius XM buy Pandora..."

    Why not?

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