Understanding Sirius' History Of Converts May Ease the Pain

by: Tyler Savery July 29, 2008 | about stocks: SIRI    

Tyler Savery

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While Monday’s trading action would be cause for concern to any investor, it always helps to understand the full perspective of what happens with converts, and why. Even some well known financial publications and analysts had confusion over the activity surrounding the equity offering Monday.

What investors should know is that holders of converts typically short the stock, thereby minimizing risk, and locking in the interest they are receiving as a profit. This strategy is not unique to Sirius (SIRI), and in fact happens all of the time. Still, even understanding this likely does little to appease the frustration of investors who were hoping to see positive momentum on these equities.

Thus, if you are a frustrated investor, I do not blame you. But, let's take the next step and see what usually transpires. With the convert holders shorting, there are large numbers of shares hitting the market within a short period of time (from a few hours to a few days typically). This selling activity drives the price down, but in many ways, the sale is “artificial”. Think about it this way. The companies doing the selling are holders of converts. Because they have converts, they must have some interest in the company succeeding. Their sale is less about their sentiment on the company, and more about locking in a profitable position which allows them to continue to do business. Their play is the arbitrage of the trade.

This is all well and good, but in real terms there are only buys and sells. Sells take the price down, and buys bring the price up. From the perspective of the market, a sale by a holder of a convert is identical to a sale by someone who wants to simply get out of their position, or a sale by a short that believes that a company will fail.

With that background, there is a bit of a silver lining. When the holders of the converts finish selling, the “pain” is virtually over, and the stock will stabilize, or perhaps even rebound. With that in mind, let’s look at what happened with the last two converts issued by Sirius.

On May 20, 2003, Sirius offered converts. Notice the pricing activity just prior, just after, and then a few days down the road. The selling activity of the convert holders drags down the price. However, once that selling stops, the stock price stabilizes, and then recovers to an even higher price point.

The next convert offered by Sirius came in conjunction with a secondary offering, but nonetheless, the converts would naturally short the equity. This convert happened on October 13, 2004. Notice that the trading days following the convert, the stock drifted down, but then recovered and stabilized. This convert happened just prior to the Howard Stern announcement. The stock obviously responded well to the Stern news shortly after the dates illustrated, but I wanted to show what transpired absent that news.

Many times converts are issued to raise capital or restructure debt, so that the company is in a better position. In this case, the converts are required to consummate the merger with XM (XMSR). While there is some pain associated with them, the theory is that the results will deliver benefits. Sirius is taking steps to have a merger that promises synergies that will translate to the bottom line.

While this analysis is simple, the concept is sound. When the selling stops, the equity can balance, and take their next steps forward.

Position: Long Sirius, XM.

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This article has 20 comments:

  •  
    Jul 29 08:47 AM
    Excellent point! The merged company now has the ability, the products (every sport on one radio), and the scale to succeed where the two companies independently were in the 'doubtful' category. The new pricing, the new receivers for the retail side, and the ability to 'activate' a lot of customers with SAT radio in their cars who did not keep them after the free period will not be able to get the ala carte pricing at $6.95. That and the reduction in overhead makes for a good 'long' play in the stock.
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  •  
    Jul 29 09:11 AM
    Do not forget the used car market. Lots of cars on the lots with sat. radio. Alot of those will be activated.
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  •  
    Jul 29 09:23 AM
    Sirius and XM have been in trouble for a long time. Mel knew it so he hook up his stock price with XM to help preserve the massive satellite bubble that had inflated. Now the arb buyers are leaving and you're seeing all of the value sucked out. You can argue that this is a short term temporary event, but I don't believe it. Even with their monopolistic position there is no justification for the current valuation on the two companies. I see this one ending badly for their shareholders.
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  •  
    Jul 29 09:48 AM
    Yes, with all this exciting specualtion I wonder if the stock will drop below $1 today and then stabilize!
    Reply | Link to Comment
  •  
    Jul 29 10:10 AM
    Massive satellite bubble? Companies that haven't been profitable for years trading at a couple bucks each, ooh look out for that bubble.
    Reply | Link to Comment
  •  
    Jul 29 10:40 AM
    love my siri all my limos have it!!!
    good luck longs
    Reply | Link to Comment
  •  
    Jul 29 11:07 AM
    Dobie, Still got your head stuck up Mel's butt? You should have asked him for some KY to ease the pain of the reaming you and all the other Xm & Siri shareholders are taking from this great management. Looks like Howie , Mel, and the other insiders are the only ones making money. Next will come the inevitable reverse split, followed by further dilution, followed by bankruptcy. How will you spin this catastrophe then?
    Reply | Link to Comment
  •  
    Jul 29 01:25 PM
    Yes, I understand the idea of multiple contraction. That was a tongue and cheek post, I guess I am really tired of everything being called a bubble. However, it is hard in the world of mathematics to obtain a valuation when your E (earnings) is a negative number.
    Reply | Link to Comment
  •  
    Jul 29 03:38 PM
    Those who are long SIRI, I've posted it a few times over the past few weeks, but you don't seem to be getting the message: take your tax loss and move on. No matter how "cool", this technology is far too expensive to finance, proven by today's stock action on the news of yet more dilution. Although when you're losing money at the rate this company does, yet another public offering actually lowers the loss in per-share terms.
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  •  
    Jul 29 06:08 PM
    I concur. It makes no sense to own these shares anymore. The combined company needs to refinance a huge portion of its $3+ billion in debt, and the company is going to do what it takes to make bondholders whole, even if it means breaking the backs of gullible sports-fan mentality equity holders such as yourselves. The convertible bonds just issued will pay their holders more than 6% a year, then they get all the upside if the stock ever recovers (which it won’t). With that kind of a coupon, it’s meaningless to own the common shares.

    Those of you who bought high have my sympathies. It’s not too late, however. If you sell now, maybe you can take what pennies you have left and buy convertibles or an index fund. At least you’ll stand a chance of making yourselves whole again someday. Good luck, it’s a painful lesson. I’m embarrassed for all of you.
    Reply | Link to Comment
  •  
    Jul 29 06:13 PM
    Mr. Savery, what is your background in convertible bond analysis and their impact on a company's capital structure? All I hear is peripheral rhetoric and sales lingo from your columns.
    Reply | Link to Comment
  •  
    Jul 29 06:59 PM

    This information appeared in a column entitled "MOST READ: Sirius and XM Together at Last" on “THE STREET.COM” written by Robert Holmes who has previously been an advocate of the Merger and believe like many of us including J. Cramer that the stock was going to pop. Unlike Cramer who has not admitted in his err in judgment, Rob Holmes has. I understand he his lending his advice on what to do next, but have not found the article. I believe that the accounting principles will have a lot to do with the stock price in the short and long run, mainly the long haul. Now I am going to put something out there that is really off the wall, so all you I told you so Nab fans can call me an jackass. Wouldn’t it be something if Howard Stern said something encouraging such as he would work with Sirius XM through their painful period and possibly others as well? After all he disdains terrestrial radio and I am amazed that he was able to clam up while this merger was going on. I don’t know the guy on a personal basis because I am just an ordinary guy that got his ass handed to him twice in a row, but I do know someone who does and says he is really a great guy and after the last 493 + days I can believe anything at this point. My break even point is $2.88 and my gut told me to sell the other day when it reached 2.60+. Hindsight is always 20 20. Now I sound like Yogi B. It’s all about economics now the financing has been set.

    Is there an accountant out there amongst you, that can shed some thoughts on Siri's belief on the accounting principles that the have cited.

    The terms of the offering call for Sirius to lend the stock to affiliates of Morgan Stanley and UBS, and the shares will eventually be returned. While the "borrowed" stock will be considered issued and outstanding for corporate law purposes, Sirius believes that U.S. generally accepted accounting principles don't require the shares to be outstanding when per-share earnings or losses are calculated, because of the fact that they will be returned.

    April Horace, an analyst with Janco Partners, said that shares of Sirius are dropping because no one expected the newly combined company to issue debt. "That wasn't expected or anticipated," she says. "Sirius' equity offering is a little confusing. The debt holders don't want to have the exposure of the exchangeable debt, so Sirius is issuing common stock shares to these debt holders so they are hedged."


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  •  
    Jul 29 07:04 PM
    I wonder if I should buy siri back? Maybe for some momentum play?
    Will it go lower back below $1? Why is the volume so high on this stock??
    Reply | Link to Comment
  •  
    Jul 29 08:26 PM
    Well yeah it will probably go below $1 after all this is a fear driven enviorment. Will it stay there now that's another issue.Is it an opportunity?

    This is a game of information as well as numbers. Why didn't they go ahead and announce earnings already?

    They could have done today or even tomorrow. Latest I've seen is an expectation for Friday. I could see that extending into next week, after all this hoopla settles down. If they had a positive spin to announce it would be destroyed in this negative enviorment. I know it's a big if, but Sirius is not run by stupid people they know what they are doing.
    The only ones getting hurt right now are the fearful and short sighted. After all it is called an UNREALIZED LOSS for a reason. Unless you have placed your house payment in the kitty, relax and enjoy the show.....and if the former is the case SEEK HELP this game is not for you.
    Reply | Link to Comment
  •  
    Jul 29 08:51 PM
    calm voice the earnings come out b4 the open on thursday
    Reply | Link to Comment
  •  
    Jul 29 08:51 PM
    calm voice the earnings come out b4 the open on thursday
    Reply | Link to Comment
  •  
    Jul 29 08:56 PM
    Hello A Calm Force --

    Well, I was looking for an accountant but I will take the advice of your "Stick/Handle&quo... at this time. You make a good point about the earnings call and maybe they are waiting as well to ensure that their interpretation of how they view their stock issuance is correct. Let's hope they did their homework and the likes of Mr. Adelstein don't have a say in the ruling.
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  •  
    Jul 29 08:58 PM
    I meant a Calm Voice - I have only one hand to type with for a while, and it ain't a picnic. JJ
    Reply | Link to Comment
  •  
    Jul 29 10:01 PM
    Check out this -cs.schwab.com/clicker/...

    Explains the financing more accurate than Cramer did.
    Reply | Link to Comment
  •  
    Jul 29 10:48 PM
    so any chance this will see $2.60 before 2010
    Reply | Link to Comment
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