Sirius XM Has More Upside

Satellite radio giant Sirius XM  (NASDAQ: SIRI  )  has been doing very well in terms of growing subscribers and revenue. The company is in the process of being bought out by its controlling shareholder. However, the deal from Liberty Media (NASDAQ: LMCA  )  severely underprices the value that Sirius stockholders are getting. Sirius' independent board should turn down the deal on behalf of all minority shareholders and negotiate with Liberty for a higher bid. 

Rapidly growing company 
With a subscriber base of 25.6 million and growing, Sirius is the leading satellite radio broadcaster and has predictable cash flows owing to its subscription business model. In addition, Sirius owns a 38% stake in Sirius XM Canada, and that business has more than 2.4 million subscribers. The company generates valuable royalty fees from its investment holding in Sirius XM Canada as well. The company is also increasing its footprint with more on-demand features through the Internet and mobile apps.

Sirius XM radios are installed in roughly 70% of all new cars being sold in the U.S. The total number of cars with a satellite radio in the U.S. has surpassed 57 million cars, out of roughly 240 million cars in the nation. The company's management is hoping to double the number of cars preinstalled with a satellite radio in the next five years, a move that will increase its addressable market in the U.S. substantially.

Just recently, Sirius XM extended its deal with Nissan North America until the end of 2018. Under the deal, customers buying a new Nissan will get a three-month subscription from Sirius XM's All Access package, which provides more than 150 channels of music, sports, news, talk shows, and more. Making such distribution deals with automakers and giving out more trial offers will enable the company to convert these consumers into paying customers. The company currently has 20.7 million paying subscribers.

Additionally, Sirius is tactically targeting the used-car market as those preowned cars hit the secondary market. The company is now working with more than 8,000 car dealers, a big increase from 3,000 at the start of 2012. The company is also trying to figure out more effective ways to target women and Hispanics, segments of the markets that have been historically underrepresented in its customer base. 

The company's growth of net new subscriber additions was phenomenal last year. Sirius XM added 1.66 million net subscribers in 2013 and gave guidance to add another 1.25 million new subscribers for 2014. Sirius' management estimates that the company will be generating almost $1.1 billion in free cash flow on record revenues of $4 billion for the full year of 2014. The company really is firing in all cylinders, and deserves much higher valuation multiples compared to current levels. 

Deal with Liberty will provide more upside
Liberty Media owns 52% of Sirius and has put forth a bid to buy out the minority shareholders for an all-stock transaction. Under the offer, Sirius XM minority holders will receive non-voting Class C shares of Liberty at an exchange ratio of 0.0760, which points to a value of roughly $3.68 per share of Sirius. This deal severely undervalues the intrinsic value of Sirius' future growth, and is an attempt by Liberty to strike a very lucrative and profitable deal for itself.

However, Sirius XM was the recipient of a large number of lawsuits; as a result, the company's independent board retained Evercore Partners to help structure a deal that might be more representative of Sirius' intrinsic value for minority shareholders. So, Liberty will have to sweeten the pot to take the company private. 

Liberty Media owns 27% of the fourth-largest cable provider in the U.S., Charter Communications. Since Liberty yields a lot of influence over Charter, Liberty will be utilizing Charter as a vehicle for making another bid for Time Warner Cable. The board of directors at Time Warner rejected a bid from Charter for the third time. Charter's bid stood at $132.50 and was rejected unanimously, and it is now expected to make a higher bid.

Liberty wants to have a larger market cap, which would allow it to leverage Sirius XM's balance sheet. A stronger balance sheet would enable Liberty to place a larger bid for Time Warner Cable through Charter. However, Liberty has to make a more compelling offer to Sirius XM's minority shareholders, which needs to be higher than $4 a share. 

The bottom line
The best-case scenario for both Sirius XM's minority shareholders and for Liberty is if the company stays publicly listed. That way, Sirius' growing revenues and subscriber base will fetch higher valuation multiples in the public markets. Since more than 75% of Liberty Media's market cap is tied to the market value of Sirius, the controlling shareholder stands to gain big.

With higher automotive distribution and more households subscribing to Sirius XM, the company has very strong growth prospects. The company's churn rate at 1.80% is at record lows, and its average revenue per user is at record highs as well. Sirius is generating a lot of free cash flow, and the intrinsic value of the company is in the region of $5 per share, if not higher. As a result, the deal from Liberty has to be a lot more lucrative and will provide more upside.


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