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The SiriusXM Lesson: Thriving Stocks Left for Dead During the Crisis

Liberty Media tunes into SiriusXM

With SiriusXM, one of the market's most compelling battleground stocks, analysts deserve credit for sticking with their fundamental expectations for the company, and in particular, its dance with large minority shareholder Liberty Media even as shares gyrated in 2012.

As SiriusXM shares fell below $2 in June, well below the consensus analyst estimate, the satellite radio giant looked like yet another prime example of overoptimistic expectations clouded by M&A hype. Noting changes in SiriusXM's relationship with Liberty Media and a recovery in its earnings, balance sheet and cash flow, analysts stuck with optimistic calls for Sirius to rise to $2.50 -- beyond $3, in some instances.

After SiriusXM reported strong user, earnings and cash flow growth in second quarter earnings and Liberty Media subsequently bolstered its stake in the company to 46%, the Wall Street optimism appears vindicated.

Three years after Liberty Media caught the market bottom with a 40% stake in SiriusXM, investors and analysts entered 2012 with the prospect that the easy money had been made on the company. But a detailed look at SiriusXM's earnings and takeout prospects gave many reason to remain optimistic.

Liberty Media gained its SiriusXM stake as a result of a $530 million loan it provided the satellite radio company in 2009. A standstill agreement that prevented Liberty Media from increasing its SiriusXM stake for three years expired in early 2012, paving the way for Liberty Media gain control, which it's almost done with recent stock purchases.

In February, anticipating the end to Liberty Media's lockup, Citigroup analyst Jason Bazinet made the argument that M&A could drive SiriusXM's stock in 2012, justifying a buy rating and $2.50 price target. As Liberty builds its stake, those expectations seem justified.

Deal speculation centers on whether Liberty Media will look to buy SiriusXM through a merger and tax-free spinoff transaction called a Reverse Morris Trust, or through a direct acquisition to take advantage of billions of net operating losses [NOLs]. However, a SiriusXM FCC petition and subsequent request by SiriusXM to block Liberty share sales portrays the two companies at odds over the M&A end game, with the prospect that hostilities benefit shareholders.

"We see Liberty's purchase of another 2% of SiriusXM, taking its stake to 48%, as raising the probability that it ultimately takes control, appoints a new board, and pushes through a big share repurchase," wrote Lazard Capital Markets analyst Barton Crockett, in an Aug 16 note to clients. "We see the potential of a big repurchase as positive for both Sirius and Liberty, prompting a $0.15 hike in our Sirius price target to $3.00," he adds.

Liberty Media bought 90 million shares of SiriuxSM from Aug. 10 to Aug. 14 at a price of $2.48 and a forward contract for the right to buy 220 million additional shares for $2.05 by October 11, paving the way for the company to have a controlling stake by the fall. That could immediately lead to $7 billion in share repurchases, Crockett of Lazard adds.

"We view reaching a resolution with Liberty as a key future positive development for the stock as it will remove an overhang that has made many investors reluctant to own SIRI," noted Bryan Kraft in a report assessing SiriusXM's earnings earlier in August.

Overall, the company has 3.83 billion shares, meaning that its share price of $2.53 still gives SiriusXM a near-$10 billion market cap.

Where are they now?: While Sirius shares have rallied to a 2012 high, the rally may continue, even if the company's M&A battle drags. "The probability of [Liberty Media] executing a spin-merge of its SIRI stake during the next 12-18 months is low," writes Kraft of Evercore in an Aug 20 research note. That comes as SiriusXM's earnings momentum looks positive and Liberty Media is still expected to play a big role in a dividend.
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