By Demian Russian
Citigroup (NYSE: C) analyst Jason Bazinet upgraded Liberty Capital (NASDAQ: LCAPA) today, based on an updated “sum of the parts” valuation, and sees Liberty boosting their stake in Sirius XM Radio (NASDAQ: SIRI) likely, but not until 2012. Mr. Bazinet upgraded Liberty Capital to BUY from HOLD and raised his price target from $46.00 to $54.00. Bazinet also reiterated his BUY rating on Liberty Interactive (NASDAQ: LINTA), but lowered his price target to $15.00 from $18.00. In his report, which was largely focused on Liberty Media Corporation’s (NASDAQ: LCAPA, LCAPB, LINTA, LINTB, LSTZA, LSTZB) stake in Sirius XM, Bazinet lays out several possible scenarios Liberty Media may take in regards to their current stake in Sirius XM.
Liberty Media’s 40% stake in Sirius XM is currently represented in its Liberty Capital LCAPA tracking stock. Last month, Liberty announced a plan to separate its Liberty Starz and Liberty Capital tracking stock groups from its Liberty Interactive tracking stock group. If Liberty’s plan gains approval, Liberty Capital and Liberty Starz would then become apart of an asset-backed company called “Newco.” The newly formed Newco would be represented by two separate tracking stocks, Newco Starz and Newco Capital. Meanwhile, Liberty Interactive (LINTA) would then become asset based. In light of Liberty’s decision to not do a hard spin of LCAPA, LSTZA and LINTA, Bazinet’s analysis focuses on how Liberty may create increased shareholder value over the next couple of years.
What does Bazinet see as the most likely scenarios? He sees Overture Films, which is currently part of Starz Media and represented by Liberty Capital, being shuttered or sold. He then sees the remaining Starz Media assets, in exchange for cash, being re-attributed to Liberty Starz. In order to lessen or remove the tracking stock discount, he expects Newco Starz to “ultimately be spun out as an asset backed security.” Bazinet then sees the newly created Newco Capital either entering into a tax sharing agreement with the newly created Newco Starz, or entering into a RMT (Reverse Morris Trust) transaction with Sirius XM.
A Reverse Morris Trust transaction allows for a parent corporation to spin-off a subsidiary tax free into an unrelated acquisition corporation, but the parent company’s shareholders must retain a controlling interest (over 50% of the value and voting rights) of the newly merged company. Recent Reverse Morris Trust transaction examples include Walt Disney’s (NYSE: DIS) $2.4 billion spin-off of ABC Radio into Citadel Broadcasting Corporation (NYSE: CDL) in 2006 and Verizon Communication’s (NYSE: VZ) $2.7 billion spin-off of its Northern New England wireline operations into FairPoint Communications (OTC: FRCMQ.PK) in 2008.
Bazinet sees three potential options for Liberty’s stake in Sirius XM
- Liberty making a tender offer for 100% of Sirius XM between March 2011 – March 2012.
- Newco Capital, the new tracking stock, increasing its 40% stake in Sirius XM to 80%.
- Newco Capital spinning off its Sirius XM stake into a new company and then using a Reverse Morris Trust to merge with the publicly traded Sirius XM (SIRI)
In his report, Bazinet explores the many factors which will influence Liberty’s decision. In the investment agreement with Sirius XM, Liberty is restricted from acquiring more than a 49.9% stake in Sirius XM before March of 2011. Liberty is permitted to acquire more than a 49.9% stake after March 2011, as long as Liberty makes a cash tender offer for all of Sirius XM’s outstanding shares it does not already own at a price above the closing price. After March 2012, Liberty is allowed to acquire more than a 49.9% stake, and a controlling interest, without making a tender offer for all of the outstanding shares they do not own.
Sirius XM has approximately $8 billion in NOLs (Net Operating Loss Carry Forwards). Bazinet notes in his report that “Section 382 of the IRS code limits the amount of NOLs that can be utilized per year should a change in ownership of greater than 50% of a company’s stock occur over a three-year period.” In the event that Section 382 of the IRS code is triggered, Bazinet estimates that the annual NOL utilization limit ranges from around $200 million to $400 million, when factoring in a SIRI stock price of between $1.00 – $2.00 right before a change in ownership would occur.
Should Sirius stock trade at $1 per share at the time of the ownership change, we estimate there could be about $4.7 billion in NOLs that could go unused. Alternatively, if Sirius stock is trading at about $2 per share, we believe unused NOLs could total $1.8 billion.
– Jason Bazinet, Citigroup Media Analyst
“I mean we have an excess of cash and we have to figure out what is clever to do with that. And having an unshielded income stream over the long term, unshielded by debt, or other tax advantages, is probably not an attractive scenario.”– Greg Maffei, CEO of Libert Media Corp.
What would Liberty’s cost be to increase its stake in Sirius XM? While Bazinet admits that it’s “difficult to know where Sirius XM will trade in the next year, or the year after,” he points out that it’s dependent on Sirius XM’s equity value at the time combined with the level of Liberty’s target equity stake. He notes that a larger than 50% controlling stake is required to complete a Reverse Morris Trust transaction, and an 80% stake in Sirius XM is required to allow both Liberty and Sirius XM to use the NOLs. Importantly, Liberty needs to acquire an 80% stake within six months after it attains an over 50% ownership for Liberty and Sirius XM to both be allowed to utilize the NOLs.
A tender offer for 100% prior to March of 2011 seems highly unlikely, according to Bazinet. There are few incentives for Liberty to do this, as it would destroy Sirius XM’s NOLs. If Sirius XM’s stock price remains at “current levels” over the next couple of years, Bazinet “expects” Liberty Media to boost its stake in Sirius XM to 80% — after March of 2012. He notes many reasons for this, including the “significant” benefit from the sharing of the NOLs between Sirius XM and Starz. “The effective cost to Capital would be $1.6 billion when taking into account the value of accelerated NOL usage under a tax sharing agreement between Sirius and Starz,” explains Bazinet.
If Sirius XM’s stock were to rise “substantially” in value, Bazinet expects Liberty Media would enter into a Reverse Morris Trust with Sirius XM. While the accelerated utilization of the NOLs would be taken off the table with the RMT option, it could actually be substantially less expensive, because Liberty Media would gain control as a result of contributing its existing stake in Sirius XM and then merging it with the publicly traded Sirius XM. What will ultimately happen? Watch the SIRI ticker and the tick of the clock.
Position: Long SIRI
Contact the Author: demianrussian@satelliteradioplayground.com
Here is another situation to consider…. after the stand-still agreement expires Liberty could purchase SIRI’s stock and treat the transaction, for Federal tax purposes, as a IRC Sec 338(g) transaction. With this election, SIRI “sells” Liberty its net assets at FMV. By doing this SIRI would trigger a taxable event and would be able to use its NOLs to offset the tax situation of this event (its very possible the all of the NOLs could be extinguished all at once). Obviously a full analysis of how much gain on the “sale” of assets (difference between current FMV of each individual asset vs. tax basis) would actually occur vs. amount of NOLs – I do not know the exact numbers but based on SIRI’s balance sheet it could be huge. Let’s assume the gain is greater than the amount the NOLs, this woudl allow Liberty to accomplish: 1) putting to use all the NOLs SIRI generated immediately; 2) stepping up the tax basis of each asset to the FMV value at the date of the sale without potentially paying any taxes; 3) own 100% of SIRI.
I’m not saying this what I think will definitely happen, but its just another consideration in those whole game.
http://macabacus.com/taxes/section338
“Section 338(g) elections are rare because the current tax cost of the deemed asset sale usually exceeds the PV of tax savings from the tax basis step-up. Generally, a 338(g) election is only advantageous when the target has substantial net operating loss (NOL) or tax credit carryovers that the acquirer can use to offset any taxable gain triggered by the deemed asset sale. These tax attributes are available only for immediate use and do not survive the acquisition if the target is liquidated.”
Demian – Putting aside for a moment that the market always values media on EBITDA multiples. Of course Sirius is valued the same.
But when you look at the move from 5 cents to a dollar a share after Liberty invested, common sense tells you that the market is very certain that Liberty and Sirius will be tied at the hip forever in one way or another. The market is saying they already are and will continue to be.
The form is really irrelevant as long as Mel runs the company and Howard stays. Malone is unlike Redstone in that he seems to understand perfectly that this is all about Mel being the CEO and running Sirius to increase shareholder value. It seems to all come down to Mel, and you have to respect Malone for seeing that. They seem to be on the exact same page.
Yup, I also agree with this. I think a lot of people who are in Sirius right now know nothing about John Malone’s style. John Malone is no Carl Icahn.
Demian,
Very well put together…. Puts all the speculation into perspective. It looks like Mr. Bazinet has done his homework and is putting some real “meat” behind his speculation.
The real question for me is, “Can Liberty get approvals for its own restructuring, a little less than two years for the March 2012 scenario, to be able to be the only “bidder” for those NOLs and the company’s growing FCF machine?. Obviously they are in the envious position of already owning 40% of the company, and about $460M of the company’s debt at last reporting, so the advantage goes to them.
I also like as mentioned by Muscle above, that usually this type of merger leaves management in place to run the company. So its really a win for us investors.
Demian, very good job… however, one correction:
“The Sirius XM NOL limitation ends three years after Liberty’s March 2009 initial investment, in March of 2012.”
The above line is incorrect. The 3-year limitation was triggered with the merger of Sirius and XM. This caused the limitation in usage, which would be further complicated if a 50% change were to occur before August 2011.
The enacted shareholder rights agreement (poison pill) notes this. This is why the poison pill lasts until the end of July 2011.
The rest of what you said is all very good and well researched.
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Remember, the NOL limitation was triggered by a 50% ownership change in the first place (the merger), not a 40% change. That is why Liberty was prevented/restricted from going over 49.9%… because “another” 50% change within the 3-year timespan would be two 50% changes.
homer985, I was wondering also whether the NOL’s in this case stayed with the company that owned them, and thus the 3 year clock then falls to their last change of control, which in this case would be SXM’s merger as you describe, or if the “acquiring company” had a waiting period form thier initial, greater than 5% ownership status for this type of transaction to be approved for use of the NOLs, by the analyst’s described Reverse Morris Trust scenario….
Homer,
I believe you may be correct. I still have a little confusion about some of the details of the NOL limitations from a Liberty perspective. I’m doing more research on that now. In the meantime, I took the sentence out.
Always appreciate your input.
Thanks for keeping me on my toes.
Let’s not forget that John Malone and Mel Karmizin are friends.
Are they? I know that Mel had many dealing with Malone when Mel was at Viacom. I believe the BET deal involved both and I remember all the other cable deal rumors – Discovery, Starz and Showtime together etc, but those rumors never came to fruition.
It seems to me that Mel and Malone are on the same page as far as being driven by EBITDA and free cash flow numbers and only focused on shareholder value. I think Malone understands just how great Mel is in radio. There is obviusly nobody better in history. Nobody even comes close.
Demian and Cos… here’s an old article from right after the Liberty deal… it was the starting point for me to learn what was going on:
http://taxprof.typepad.com/taxprof_blog/2009/02/wsj-why-the-frenzy-to-buy-nearbankrupt-sirius-6b-in-nols.html
It was originally published by the WSJ. Keep in mind, Sirius can keep the NOL’s for themselves — just as Liberty suggested they would. But, Liberty through their ownership of Sirius, can benefit indirectly by those NOL’s.
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Homer,
I remember reading that same article as well. There was a change of control at the time of the merger which triggered the NOL limitation clock, no doubt. What I’m researching is the minutia of tax law regarding the utilization of the NOLs under different scenarios from Liberty’s perspective. That’s where my uncertainty is.