2023-06-12 15:48:28 ET
Summary
- Liberty Sirius XM (LSXMA; LSXMB, LSXMK) is expected to streamline its holding structure, providing an opportunity to acquire a growing and stable business at a c16% look-through Free Cash Flow yield.
- The separation of Live Nation from LSXM will help reduce the current discount to Net Book Value and facilitate future corporate actions.
- The main asset of LSXM is Sirius XM, a stable subscription business trading at a generous free cash flow yield, which will be used for buybacks and provide added return while waiting for the discount to close.
Liberty SiriusXM ( LSXMK ; LSXMA ; LSXMB ) is a holding company carrying Liberty Media’s interests in Sirius XM ( SIRI ) and Live Nation ( LYV ). LSXM has been trading at a significant discount to the value of the assets for a number of years, though as of late management has stepped up efforts to close this discount. The upcoming streamlining of the SIRI holding structure will create a unique opportunity to acquire a growing, cash-generative and stable business at a c16% look-through Free Cash Flow yield.
Liberty Sirius XM is the controlling shareholder of Sirius XM and can use the free cash for buybacks at the holding or the Company level. Even if management would fail to close the discount to underlying assets, they could continue growing the underlying value of LSXM shares through buybacks. At a c16% FCF yield, they can buy a lot of stock back.
The expected discount on new LSXM
Liberty Media is split into 3 tracking stocks (Liberty Sirius XM, Formula One and The Liberty Braves), to better reflect the underlying values of the diverse business interests and reduce the conglomerate discount. Sirius XM, however, was lumped together with Live Nation ((LYV)) shares when forming LSXM. This made it difficult to arbitrage and close the discount to underlying assets as compared to other trackers. LSXM has been trading at a c35% discount to the Net Book Value, whereas Liberty Expedia, a former pure tracker of Liberty Media, had been trading at a 15-20% discount to the value of its holdings of Expedia Group.
After the planned corporate action, LSXM will only hold the SIRI interest as well as some debt. Since SIRI is a large publicly traded entity, it will become possible to arbitrage the price difference between the two directly. We believe that once the holding is streamlined the discount will narrow and be even lower than in the case of Liberty Expedia.
New LSXM structure (Liberty Media CMD)
There is one really significant difference between the two. Liberty Expedia owned only c17% economic interest of Expedia, so any dividends it received were taxed as income at the holding company level. Liberty Expedia traded at a larger discount to Expedia because it had to share the value of its holdings with the tax man. This will not be the case at LSXM.
SIRI has been making significant share buybacks for a number of years, effectively increasing the ownership interest of LSXM. A couple of years ago the holding crossed a very important 80% threshold, enabling LSXM to consolidate SIRI for tax purposes. Effectively, Sirius XM has become a subsidiary of LSXM in the eyes of the tax man and dividends from a subsidiary are not taxed. From a purely economic perspective, LSXM and SIRI will be the same after the restructuring is complete.
From a corporate governance perspective, they are also practically the same. SIRI is a controlled company where minority shareholders’ opinions or votes do not matter since LSXM owns 83% of the Company. LSXM is also essentially a controlled tracker of the broader Liberty Media Group and its supermajority voting stock is controlled by Mr Malone. SIRI and LSXM are both controlled entities.
For these reasons, we believe that the streamlined LSXM will trade at close to the value of SIRI. Since Liberty Expedia has traded at about a 15-20% discount to Expedia shares, we believe that LSXM should and could trade at a sub-5% discount.
The first step in achieving the discount reduction will be a separation of the 31% Live Nation interest into a separate tracking stock. Management has indicated that the process should be completed by H2 of 2023, contingent on the separation of the Braves Group. Liberty Live will be a pure tracker, and just like Liberty Expedia, it might merge with Live Nation. On the other hand, Liberty Live will hold just common and not supermajority shares, so the merger might not be high in priority.
How to play it?
To take advantage of this opportunity we could buy LSXMK now and short Live Nation LYV and SIRI. If we assume that Liberty Live will merge with Live Nation in not too distant future, we could see the discount evaporate entirely within a year or two. In this case investors today would pocket a c50% profit.
This strategy relies on accurately guessing future market expectations and trading behaviour of market participants and as we know markets are not always efficient and market participants are not always rational. Another way to play it would be to take an open long position of LSXM now, wait for the distribution of the Live Nation tracker, sell the tracker at a reasonable discount to net book value and reinvest the proceeds to streamlined LSXM at a reasonable discount to book value, or pocket the proceeds otherwise.
The latter strategy has a significantly longer duration but also opens us up for greater return optionality under random market behaviour scenarios. If we sell Liberty Live at a reasonable discount and hold the new LSXM until the discount is almost closed, our realised return will most likely be lower, depending on how long it will take us to sell the Liberty Live tracker.
USD billion | ||
A | LSXM equity value now | 9.5 |
B | Liberty live exp. price | 3.8 |
C | LSXM new net cost to us | 5.7 |
D | LSXM new net book value | 8.9 |
E | Profit | 3.2 |
Return on initial investment (conservative) E/A | 34% | |
Return on initial investment (best case) E/C | 56% |
Our estimates
On the other hand, if the LSXM discount persists or even increases after the separation, we will do just fine with this strategy. LSXM can just buy its share back using the tax-free dividends from SIRI, grow look-through earnings per share and wait for the increasing discount to close eventually. At the current price, the look-through adjusted FCF yield of LSXM is likely to be about 15-18%, giving them significant firepower for buybacks.
The generous cash yield should charge growth
Assuming that SIRI can generate 1.2bn adj. Free Cash Flow after the peak capex cycle ends, LSXM would be entitled to about a 1 bn of dividend if all free cash was paid out. Liberty Sirius has a market cap of $9.5 bn, and the value of Liberty Live tracker is likely to be $3.8 bn, for an estimated cost basis of new LSXM of $5.7 bn. We would generate a look-through FCF yield of c16% on our cost basis.
Liberty Live | Shares | Price | Value bn |
Live Nation | 69.6 | 82 | 5.7 |
Debt | 0.92 | ||
NBV | 4.8 | ||
Tracker discount | 20% | ||
Market Value | 3.8 |
Our estimates
LSXM | Value bn | |
A | LSXM current M. cap | 9.5 |
B | Proceeds from Liberty Live disposal | 3.8 |
C | LSXM net cost basis | 5.67024 |
D | SIRI adjusted FCF | 1.2 |
E | Siri ownership interest | 83% |
F | FCF attributable to LSXM | 1.0 |
G | LSXM holding debt cost | 0.09 |
Look Through Yield on cost basis (F-G)/C | 16.0% |
Our estimates
This look-through FCF yield is likely to grow rapidly if:
- SIRI will be buying its shares back and increasing EPS as well as per share FCF.
- LSXM will be buying back its own shares using the dividend proceeds from SIRI.
- SIRI revenues and profits are also likely to grow.
This basically means that, if a discount to NBV at LSXM persists, in a few years we are very likely to have 20%+ look through cash flow yield on our cost basis. Assuming that a quality business like Sirius XM should trade at a sub-10 % FCF yield, we would stand to double our money within 2-4 years. How fast exactly will depend on capital allocation strategies adopted by SIRI and on market behaviour. With an open long position in LSXM, we would generate an attractive return even if the discount to NBV takes years to close.
Likely pace of value growth
Last year SIRI had a payout ratio of c30% and generated 1.2 bn of net income, 360m was paid out in dividends and about 800m were retained and used for buybacks. LSXM passed the 80% holding in SIRI a couple of years ago and then started increasing dividend payouts significantly as the subsidiary was integrated for tax purposes. SIRI will most likely continue increasing dividend payouts and share buybacks at LSXM level but has not disclosed the expected dividend for next year. The payout ratio cannot be jacked up to 100% right away, especially when the future discount of streamlined LSXM is unclear.
The higher the payout the more value can be created at the tracker level due to buybacks at a discount to net book value. We will assume that streamlined LSXM will trade at a 20% discount to net book value after the Liberty Live separation. This discount is chosen just for illustrative purposes.
Liberty Sirius XM | Shares | Price | Value million | |
SIRI | 3,205.8 | 3.6 | 11,541 | |
Cash | 225 | |||
Debt | 1.375% Cash Convertible due 2023 | 993 | ||
2.125% SiriusXM Exchangeables due 2048 | 387 | |||
2.75% SiriusXM Exchangeables due 2049 | 586 | |||
SiriusXM Margin Loan | 875 | |||
A | NBV | 8,925 | ||
B | Tracker discount | 20% | ||
C | Market Value | 7,140 | ||
D | Net cost basis | 5,670 | ||
Return on net cost basis D/A -1 | 57% |
Our estimates
With a 30% Pay Out at SIRI, c4% of LSXM and 5.5% of SIRI could be bought back, for a total value growth per LSXM share of c9.5%. If SIRI PO is increased to say 70% level, 840m would be paid out and 360 retained. 10% of LSXM (after interest payment) and 2.6% of SIRI could be bought back, for a total return at LSXM per share basis of c13%. The higher the SIRI payout and the larger the discount to Net Book Value at LSXM level, the faster the shareholder value would accrue.
Under any scenario, not a bad return to just sit there and wait for the discount to shrink and provide us with an additional 50-60% return. The 9-13% per share value growth rates were estimated under the assumption that the underlying Sirius XM business stays stable and does not grow. This can be both a conservative and an optimistic expectation.
What we have is a situation where we can make an attractive return irrespective of what Mr Malone chooses to do and when he does it. Uncertainty about future actions and pricing makes this stock cheap but it largely cancels out when we estimate the eventual longer-term outcome. What really matters is the underlying performance of SIRI and the longevity of its business moat.
Sirius XM prospects
Sirius XM is one of the largest subscription-based audio entertainment platforms in the US. The company dominates the in-car satellite radio segment and is developing its online streaming offering. The highly profitable in-car business enables Sirius to invest in exclusive content which drives new customer acquisition as well as customer loyalty. Sirius XM has the lowest subscriber churn rate among its peers.
Sirius XM used to be the only provider of live premium audio content in car cars but now its dominant position is challenged by internet-based services. As the distribution pipe has been commoditized, to a large degree, SIRI is having to increasingly focus on content and service quality.
Sirius XM is home to live sports, famous talk show hosts, comedians and political commentators as well as live news and other original as well as premium third-party content. The company also owns personalised music streaming technology through its acquisition of Pandora and is now integrating it into its platforms. Overall, I believe SIRI has the most comprehensive audio content catalogue out of all subscription audio services in the market.
Satellite technology is still capable of delivering the most consistent music streaming experience on the go. The bitrate might not be the highest, but the quality is good enough for in-car listening considering the noise pollution on the road. The one area where satellite radio technology is lagging behind is personalisation because of a linear one-way connection.
Sirius is currently rolling out its next generation 360L hybrid radios which connect to satellites as well as LTE networks and are able to offer music personalisation. Having said it, the replacement of the old one-way radios will take time. The company is also developing its streaming-only product that will include all of its live audio streams as well as personalised music. Eventually, the tech stack will also include on-demand music, though the user interface might not be as good as Spotify.
The increasing popularity of other streaming platforms does make it more difficult for Sirius XM to grow its subscriber numbers. Its content, on the other hand, is still very much relevant. The increasing installation of satellite radio receivers in cars also supports its subscriber numbers. Over the past 5 years, just as Spotify, Apple and other streamers were growing subscriber numbers, SIRI not only grew subscriber numbers but also increased ARPU and reduced churn. Only during 2022, SIRI has experienced a significant reduction in net subscriber adds, but the year has seen the lowest car sales in a decade.
We do not see any evidence that Sirius XM is becoming obsolete, but we intend to investigate it further in a follow-up article. The track record of SIRI suggests that it is doing quite all right.
Is it an attractive investment?
Liberty Sirius XM provides an opportunity to generate low-risk profits due to corporate actions undertaken by John Malone’s Liberty Media. We believe that the current discount to Net Book Value at LSXM is too high and we believe that the separation of Live Nation will help to reduce this discount and facilitate other potential corporate actions. The main asset of LSXM is a stable subscription business, which currently trades at a generous free cash flow yield. This free cash flow will be used for buybacks and provides an added return while we wait for the discount to be closed. We believe this is an attractive opportunity.
Risks to the investment thesis
- As long as Sirius XM continues growing self-pay subscriber numbers this investment thesis should work out. Over the last few years company has been growing but in Q1 2023 experienced self-pay subscriber losses arguably due to a weaker economic environment and lower car sales. Negative net additions are expected for the full year. We expect the net self-pay subscriber adds to turn positive sometime next year and churn rates to remain low, but we might be wrong. Rerating SIRI to a declining business status would significantly impair the value of LSXM shares. Shorting SIRI while going long LSXM would address this issue, but reduce the upside potential of the investment.
- John Malone is a shrewd but also somewhat cunning dealmaker. To be on the safe side it would be wise to replicate his trades exactly, unfortunately in the case of LSXM, he holds the supermajority series B LSXM shares which are largely illiquid. On the other hand, class A and C holders have Warren Buffet on their team to protect their interests. Berkshire is the largest holder of these shares.
For further details see:
Liberty Sirius XM: A Free Cash Flow Growth Engine