Analysts Got It Right on SiriusXM

NEW YORK ( TheStreet) -- When it comes to rosy stock predictions, M&A hype is often the last refuge of a blown call by a Wall Street analyst. Research In Motion ( RIMM), Best Buy ( BBY) and Netflix ( NFLX) are notable examples of stock breakdowns that precipitated M&A hype.

In the case of SiriusXM ( SIRI), 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 ( LMCA). 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 on Aug. 7 and Liberty Media subsequently bolstered its stake in the company to 46%, the Wall Street optimism appears vindicated.

On Thursday, SiriusXM touched a new 52-week high of $2.60 intraday, pushing the company to its highest level since the financial crisis.

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 still gave many room for optimism about its shares.

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. In March, a petition with the Federal Communications Commission paved the way for Liberty Media to build its stake in SiriusXM towards control, which it's done in 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, and 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, the FCC petition and a subsequent request by SiriusXM to block some prospective stake increases revived speculation of a takeover by the highly acquisitive Liberty Media, and portrayed two companies at odds over the M&A end game.

Bazinet's expectation for a deal changed slightly as a result of Liberty Media and SiriusXM's FCC petitions. Now he sees a merger and tax-free spinoff as remote because of the hostile relationship between the two companies and, instead, sees Liberty Media bidding for a controlling stake.

" The lack of Sirius cooperation suggests Sirius management is doing its best to ensure its shareholders receive a control premium from Liberty," added Bazinet in a follow up note. After announcing a planned spinoff of its Starz cable channel and a boost in its ownership of SiriusXM stock to 46%, the prospect of buying shares toward a controlling stake may be warranted. Liberty would also have the ability to repurchase billions in dilutive shares that came with its 2009 bailout.

"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," writes 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 Thursday afternoon share price of $2.58 still gives SiriusXM a near-$10 billion market cap.

SiriusXM's second quarter earnings were highlighted by a 170,000 year-over-year increase in subscriber additions on the heels of a 16% rise in new vehicle sales, in addition to used car service reactivations and lower churn, according to Kraft. The company's conversion rate held at 45%.

Prior to SiriusXM's share slump in June and July, David Joyce of Miller Tabak and Martin Pyykkonen of Wedge Partners highlighted conversion rates and used car subscriptions as unheralded catalysts for SiriusXM's earnings, even in the absence of M&A.

Pyykkonen said in an April interview that the used car market may double the company's satellite services in the next three-to-five years. With SiriusXM just beginning to leverage used car dealer networks to convert previously installed satellite chips into new subscribers the company may have a strong base of prospective subscribers even if new car sales don't maintain current growth rates, as General Motors ( GM) and Ford ( F) show continued U.S. vehicle sales strength.

Meanwhile, analysts also highlight SiriusXM's growing cash flow. In 2011, SiriusXM turned free-cash-flow positive after burning cash throughout the financial crisis and just recently raised monthly subscription prices for the first time in the company's history.

In the second quarter, cash flow generation trends accelerated. Free cash flow grew over 30% in the quarter to $253 million compared with 2011, adding to year-over-year growth from the first quarter.

For another way to play the Wall Street conviction on the Liberty-Sirius relationship, Crockett of Lazard Capital Markets upped his price target on Liberty Media to $125 on Thursday, citing its expected control of SiriusXM, a less complicated Liberty balance sheet post-Starz spinoff, and stakes in assets ranging from Sirius to LiveNation.

Interested in more on Sirius? See TheStreet Ratings' report card for this stock.

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-- Written by Antoine Gara in New York

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