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On Friday January 3, 2014, Liberty Media (NASDAQ: LMCA ) announced a proposal to buy Sirius XM Radio (NASDAQ: SIRI ) in an all-stock transaction. The deal, which requires the approval of shareholders, would value the satellite radio provider at nearly $22.6 billion. On a per share basis, this would imply a value for shareholders of $3.68, 3.1% higher than the company's closing price on Friday. What exactly does this deal mean for shareholders of both companies and how does this potentially set up Liberty Media for a potential buyout of media conglomerate Time Warner Cable (NYSE: TWC ) ?
It's all in the details
Prior to the announcement, Liberty Media held a 53% equity stake in Sirius via common shares. In order to complete the transaction of Sirius, the company will issue Class C common shares in Liberty Media to all holders of Sirius stock. After the completion of the transaction, shareholders of Sirius will own a 39% stake in Liberty Media, which should have a market cap somewhere in the range of $27 billion.
However, there is some downside in the transaction for Liberty Media's shareholders. In terms of profitability, Sirius is an expensive company. Excluding the company's 2012 taxes, which were distorted by a one-time deferred tax asset being realized, the company's earnings per share would have come in at $0.09. Compared to the purchase price being paid to Sirius shareholders, the company will cost Liberty Media's shareholders 40.8 times earnings. Using the $0.08 in EPS, expected by analysts for 2013, the cost comes in at a whopping 46 times earnings!
Looking at free cash flow, the price comes down but not by much. Using Sirius's 2012 free cash flow of $709.5 million, we arrive at the conclusion that Liberty Media is paying a more modest 27.3 times. For the first nine months of 2013, Sirius recorded free cash flow of $626 million and could surpass $1 billion for the full year. If this comes to fruition, then the purchase price for Liberty Media will amount to 22.6 times.
Is Sirius a means to an end?
Although this measure of cost isn't necessarily sky-high, investors of Liberty Media might be scratching their heads a bit. Yes, it is true that Sirius has been growing rapidly, with revenue rising by 37.6% from $2.47 billion in 2009 to $3.4 billion by the end of 2012.
It's also true that the company's profitability has improved substantially, as demonstrated by its pre-tax income moving from a loss of $346.1 million to a gain of $474.5 million over the same timeframe. But at the company's current cost, and in the face of competition from companies like Apple and Pandora, both of whom have their own music-sharing programs, it's difficult to say that Sirius will still be thriving in another decade.
Furthermore, investors were under the impression that Liberty Media's ownership in the enterprise was being reduced so that it could focus on other endeavors. Back in October, the company announced a $2 billion share buyback. This was on top of the $2 billion buyback the company began in 2012, of which $1.6 billion had already been conducted. As part of the share repurchase program, Sirius announced that it was buying back $500 million worth of shares from Liberty Media in a transaction that would reduce the company's ownership to 51.6% once completed.
This drastic reversal will likely raise some eyebrows, but Libery Media should be able to rationalize it. You see, the company has become interested in a potential buyout of Time Warner Cable, the second largest cable operator in the United States. With a market cap of $37.6 billion, Time Warner would be a complicated deal for Liberty Media. This is due primarily to Liberty Media's small free cash flow of $205 million in 2012, down from the $262 million the company brought in the year before.
Though a leveraged buyout of Time Warner would bring an additional $2.8 billion in free cash flow each year, the debt load the combined company would need to take on would almost certainly be burdensome. With the hope of offsetting this expense, Liberty Media likely engineered the consolidation of Sirius, which would increase free cash flow significantly and allow the larger combined entity to assume more debt under more favorable terms.
When you add to this that any deal to acquire Time Warner would probably involve a joint effort between it and Charter Communications, the number four cable operator in the United States (and a company in which Liberty paid $4.6 billion to acquire 27% of last May), a Time Warner bid doesn't sound so outlandish.
Looking at the terms of the deal and the fact that it contradicts Liberty Media's earlier decision to reduce the company's stake in Sirius, we arrive at the conclusion that Liberty Media likely has some very strong rationale guiding it. Seeing Time Warner as an attractive target, the company began consolidating itself with the expectation of undergoing a leveraged buyout.
However, the overwhelming size of Time Warner probably made management realize that it would need significantly greater cash flows to make its dream a reality. With this in mind, the company decided to grab the 47% of Sirius XM Radio that it doesn't already own so that it could make a Time Warner deal more feasible. The trick is seeing whether Sirius accepts the company's terms or if it tries to push for a higher purchase price.
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