Fresh off news that it was buying Pandora Media (P), Sirius XM (SIRI -0.85%) slumped 8% early on Monday. It's the cheapest the stock has been in months, and investors seemed to jeer the all-stock deal. But if history is any guide, it's a bad bet to go against superinvestor John Malone, whose Liberty empire controls Sirius XM.
So the recent dip in Sirius makes now a fine time to add to your position in the company or start a new one, but there's an even cheaper way to own the stock.
Sirius gets cheaper
The deal makes a lot of sense for Sirius. Pandora helps extend Sirius's reach into cars and other mobile locations, where Pandora is especially strong. Meanwhile, Sirius's content differentiates the streamer from rival offerings at Apple (AAPL 0.81%) and Spotify (SPOT -0.77%). So on a competitive basis, it looks like a winner, leveraging Sirius's advantage in content across a wider range of potential customers.
But it also looks like a winner because of Sirius's financial strength. Unlike Pandora, Sirius stock has performed strongly over the past year, and the modest premium that Sirius is paying, just 12% on the predeal stock price, is likely a testament to the acquirer's strong stock. Pandora's weaker financial position -- the company has been generating negative cash flow for years -- also makes a tie-up with a more successful rival much more attractive. The all-stock deal also won't hinder Sirius with any more debt, allowing it to continue its ongoing stock repurchases.
If everything looks so good, why did Sirius's stock drop like a terrestrial radio signal?
In all-stock deals like this, it's not unusual to see the acquirer's stock slump as arbitrageurs come in and arbitrage the price. They're working on a short-term horizon -- until the deal closes -- and that often provides an opportunity for long-term investors to purchase the acquirer at a better price. And that's the situation here.
Sirius is expecting $1.5 billion in free cash flow this year, more than enough to offset Pandora's negative $100 million in cash burn. And then Sirius can do for Pandora what it did for itself years ago: turn around under the watchful eye of John Malone.
So just how cheap is Sirius, assuming the deal goes through? Factoring in the new shares of Sirius issued for the 85% of Pandora that Sirius doesn't own and assuming that Pandora's cash burn eats up any growth at Sirius next year, the sat-rad superstar is trading at a market cap of $31 billion or so. That's a bit less than 21 times free cash flow, or about 4.5 times sales.
That's not incredibly cheap, but it's not outrageous for the competitive advantage that Sirius gains by snapping up Pandora. But look at how shares of Spotify are trading now -- at about 5.1 times 2018 sales. Plus, Spotify is reporting significant losses as it builds market share. On this basis, a highly profitable Sirius XM looks like a great deal. But it gets even better.
The cheapest way to own Sirius
John Malone's Liberty empire holds a 70.5% stake of Sirius, which is attributed to the tracking stock Liberty Sirius (LSXMA 0.66%) (LSXMK 0.70%). Liberty Sirius's major asset is its ownership stake in Sirius. It holds about $20.4 billion in Sirius stock today as well as about $1.1 billion in Pandora and iHeart positions. It has $850 million in debt at the corporate level.
Net it all out and that's about $20.6 billion in net asset value, against Liberty Sirius's market cap of $14.2 billion. In other words, Liberty Sirius is trading at about 69% of the value of its holdings. Buying the tracking stock is like buying Sirius itself at a severe discount, so let's factor this into the equivalent price of Sirius stock. That's like buying Sirius around $4.50 per share.
At such a substantial discount, I won't be surprised to see Liberty take some aggressive moves to realize the value here, and I think Liberty Sirius makes a great purchase today.