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 Last.fm.

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.

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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.