So you don't understand everything I said but you kind of get the gist. JM pulled a fast one on you and has locked the price so it ain't going above $4.20 in the near term. So how do you make money now that you basically understand the rules of the game. You don't want to sell because you don't want to lose the tax advantage of LTG. Simple when SIRI is above $4.00, you short against the box for part of your position. Take the dummyofwallstreet who says he has 250K shares. If he had shorted 100K shares last week at 4.03 and covered FRI at 3.93 he would have $10,000 in cash in his account...a nice dividend while you are waiting for $5.00 The pros are doing this so why shouldn't you. Note the short is a separate position and does not effect your LTG in your long position. Check with your broker on the rules for shorting against the box. Or you can just complain and wait for $5.00.
Three weeks ago, I warned you that Brexit could unhinge the market. The latest poll on FRI giving it a 10 point lead did just that. I don't see the Fed raising this week due to Brexit but July is still a go. You need to understand Brexit has nothing to do with SIRI. If it occurs, the market could open 500 points down on the 24th. It will be a great buying opportunity. All of the shorts will be covering. You might as well join the party for a quick trade.
The Duke leaves on 6/18 to play in this year's WSOP. I will be coming back on 7/2 so maybe we get a post on 7/3. If we do, it might be later than usual.
Anyway, I know it is complex so let me simplify it for you. When the bonds were issued there was always a differential between the conversion price and the selling price of the stock and the bondholders were encouraged to short the stock in a riskless transaction....and they did.
So what is the deja vu all over again you ask. To begin with, the SIRI short interest for 5/31 was announced at 201.5M. Back on 2/12 it was 139.7M. That is up about 45%. Got any clue what is going on. Auto sales are flat but that isn't the big driver. So what is. The tracking stocks.
If you go back and read the article and debate between Deutsche Bank and Macquarie you will see that there is a 14% differential between the value of the tracking stock and the underlying security, SIRI. Now most of the LSXMA holders are institutions so they understand the game. They short SIRI against their LSXMA holdings and in effect capture the 14% differential in a risk free transaction. If SIRI goes down they cover the short at a profit. If SIRI goes up, their tracking stock should also go up and they would have no loss until the 14% differential was to widen. In effect, the tracking stock is acting like a convertible bond and is encouraging LSXMA to short SIRI, and they are. Deja Vu all over again and the stockholders don't have a clue what is happening. Deja vu squared.
So why is JM doing this you ask? Simple, the shorting keeps SIRI locked in that $3.80-4.05 range where he can just keep buying, or actually SIRI does the buying. Secondly, if the stock gets hammered in a market free fall, there are 201M shorts to cover and support the stock so he doesn't get a margin call. Pretty slick and no one understands what is going on which is even better.
I have actually alluded to this twice before but a recent conversation over on the LSXMA board quoted The Duke on the topic but couldn't figure out what I was saying. Deja vu all over again.
Let's go back in time to 2008 and I will show you the game that JM is playing with the stockholders. When SIRI and XM merged SIRI needed to pay off some debt that Mel mysterious forgot to refi and so he entered into a $500M convertible bond deal and supplied 274M shares for the bondholders to short against the stock.The bondholders got paid 7% per annum for the loan and could convert the shares at $1.87 at any time during the 5 years. The stock was trading at about $1.50 and given the price the bondholders had every incentive to short the stock, and they did. They shorted it into oblivion or almost oblivion. The key to understand what was going on was that as long as the stock was below 1.87, the bondholders could short with impunity because the bonds could be converted into stock, 534 shares for each $1,000 face value of the bonds they held. So if you were a bondholder, you knew you could short SIRI risk free. If you shorted and the stock went down, you could cover and make a profit. If you shorted and the stock went up and never went back down, you could hold on to the bonds, collect 7% each year and then convert the bonds to stock and pay off your short position. Basically, you were being paid to short and it was risk free. The stockholders were being hosed but they didn't understand what was going on.
Okay if you understand that, here is a different wrinkle. When the stock got above $1.87, the conversion price, the game got a little more complex. You could still short but if you made a mistake you lost out on further appreciation. Suppose you shorted at $2.40 and never got to cover. When the bonds were due, you took the stock and covered your short and got $2.40. If you didn't get caught, the stock was worth about $3.20 on the conversion date and you sold it to SIRI.
SIRI had another fantastic week if you just look at the analyst's comments. Last week I mentioned that James Ratcliffe had reiterated his BUY holding on SIRI with a price target of $5.00 that he has had for two and a half years. Then Wednesday, BOA chimed in with the same thing, SXM is a BUY with a $5.00 target and they reraised Ratcliffe by saying a dividend could be right around the corner.
Not to be outdone, two other banks chimed in on Thursday in a battle of the foreign banks. Deutsche Bank said buy the tracker for a 16% move from 32 to 37, while Macquarie said stick with SIRI because we are headed to $5.00 and JM might pay a bigger premium when he takes over the company. It is deja vu all over again. Everyone in the investment community loves the stock and tells you to buy.
So what did the stock do? It promptly feel below $4.00 for the forty second consecutive time. Deja vu all over again.
I saw Drunken on the Board saying SIRI has been consolidating again for the twentieth time and this was going to be a big summer. In November we will celebrate the three year anniversary of the Barron's cover which predicted $5.00 and Drunken will be saying any day now. Deja vu all over again.
The stock has pretty much stayed between $3.00 and $4.00 for two and a half years but everyone keeps buying the breakout story. Hope springs eternal in SIRI land.
Okay, so why hasn't the stock broken out above its historic high of $4.20. Deja vu all over again. It has just been repackaged in a new bright shiny package that investors don't understand or see. Maybe it is time to unwrap the package so that everyone can understand what is going on..and even make some money.
The problem for most investors is that they don't understand that JM's position and their hopes stand in juxtaposition to one another. You want the best price possible for your shares and his job is to keep the price as low as possible while he is acquiring the shares. So far he is winning, which means you are losing. The shares haven't gone anywhere since the first BB was announced in Dec. 2012. When the shares went past $4.00 the last time Frear told you SIRI cut back purchases. Why will it be any different this time?
I know that most of you don't know the difference between a buyout and a recapitalization so here are a few facts. When JM gets to 80% he can do a recapitalization. That what was done in Canada. Notice there was no vote. SIRI and its partners dictated the terms and the public shareholders were forced to take them. There is a real possibility that that could happen here and if you think you are getting $10.00 a share than you are really nuts.
Anyway, there is a more likely scenario that I have mentioned in the past that you should consider. SIRI has decommissioned the SIRI sats and will be operating with the XM sats. That is going to free up some spectrum that SIRI could sell to reduce its debt. That would be a good move. But what I think will happen is that the company will trade the spectrum to LMCA for its SIRI shares in a tax free exchange. That will leave you with 4B shares outstanding and I don't even want to guess the billions in debt. What do you think the shares will be worth then when half the spectrum is gone? You have another 2-3 years to watch the story unfold, so enjoy yourself.
May auto sales were worse than expected. Down 6%. Last year we sold 1,635,090 units for an average of 62,888 units a day. This year was 1,536,276 or 64,011 units a day. The Q has been flat for sales. On FRI, James Ratcliffe said SIRI will do 409K subs and 369K self pay subs in Q2. He reiterated his $5.00 call from two years ago. Hope springs eternal.
Let's take a look at where the BB will be on 6/30/17. At present the company has 5B shares outstanding and JM owns just under 3.2B. That means he will need to buy another BILLION shares to get to 80% control or so it would seem. But the number of shares outstanding is not static. The company is going to issue between 30-35M shares in the Canadian deal and then there are those pesky stock options. Most investors don't have a clue just how many options are outstanding but it is all detailed in the latest 10Q. as of 3/31/16 SIRI had 334M shares in outstanding stock options and 116M are eligible to be exercised this year. When you see the numbers, you realize the task involved in reducing the share count to 4B. The company not only has to purchase a billion shares but another 375M in shares that will be issued or exercised at some point. At current prices, you are looking at $4.00 x 1.375B equals 5.5B. The problem is that a year from now the company's debt load will be 7.8B and it will have only purchased about 50% of the 1.375B shares. Where does it go from there?
But things are even worse than they seem. When SIRI borrowed the latest Billion from the bond market it raised its leverage ratio to 3.7. The problem is that S&P has stated on numerous occasions that SIRI's bond rating is safe as long as its ratio is under 4. But what does that mean. The ratio is derived by dividing DEBT BY EBITDA. We know what EBITDA is projected to be...1.75B. What that means is when SIRI's debt hits 7B or about 900m more than it is now, the company will be at a 4x ratio. At that point things become dicey when it comes to adding more debt without S&P acting to cut the bond rating.
The other problem is that every time the PPS goes up, the company buys back fewer shares because the debt load would even be higher. So the answer to GP's question is simple. SIRI can't speed up the BB because it is running out of leverage and you show be hoping for a lower PPS rather than a higher one.
While I was attending Whitney's graduation, SIRI borrowed another Billion dollars to pay off its revolver and continue BB4. The move was generally greeted with enthusiasm from investors who may not understand its implications. In light of the move gpertr asked me this week why doesn't JM just speed up the BB so he can sell out at $15.00. Most investors are thinking about the pot of gold at the BB's end, but maybe they don't understand the difficulty in getting to the end.
So let's take a look at SIRI's debt situation and a household budget for the company beginning with Q3 on 7/1/16. At the end of last Q (Q1), SIRI had 5.7B in debt. The new debt will pay off $600M in revolving debt but leave the company with 6.1B in total debt. SIRI had 100M in cash on its balance sheet at the end of Q1 and the new debt added 400M in cash. But don't celebrate too quickly. The 2Q BB will use up about 275M of the cash leaving SIRI with about 225M of cash on 7/1/16. You need to remember that SIRI spends 90M more each month than its FCF to buy back its shares.
So let's look at SIRI's negative cash flow for the twelve months starting 7/1/16. First, lets assume the BB continues at its present pace. That means SIRI will need to borrow a Billion dollars from the revolver to fund it. Then you have about 200M for the Canadian deal and 600M for the three replacement sats it will be putting into orbit. That is 1.8B over and above FCF which will totally use up the 1.75B revolver. At that point SIRI's debt will be 7.85B and Siri will need to go back to the bond market.
It is all a matter of DOLLARS and CENTS (SENSE). JM needs to buy about 1 BILLION shares to get the 80% control he would need to take over the company without a vote. The cost would be about 4 BILLION dollars but the company doesn't have the capacity to borrow that much after it borrowed a BILLION to pay off the revolver and fund the Canadian take over.
He has no choice but to follow this strategy that will take years to execute. While the strategy is playing out SIRI will issue 30M shares to Canadian holders and have 150M shares exercised in stock options so the total cost is 5 BILLION for the takeover. In the meantime, nothing happens and people move on to greener pastures.
The question that none of you asks is what will you get when JM takes over the company? Probably a small premium but nothing like what you imagine. You will get a deal like Canada, cash representing a small premium or shares in the tracker with the hope they will appreciate...some day.
JM thinks he will live forever. The question is can you wait and what will you get?
That doesn't mean that some people haven't already figured this out. Let's take a look at the SIRI SI. On 3/31 it stood at 163M shares. This had been a pretty stable number for about six months. On 4/15 it bumped up to 171M, hit 185M on 4/29 and was 195M on 5/13. Basically, we had a 25% increase in the SI in a 45 day period. It is also fair to assume that the 32M newly shorted shares are professionals unless Roger hit the Powerball.
There is a lot of talk out there about the market hitting a new high. It is possible and I'm on record for saying it will happen before the great plunge.
As for SIRI, the breakout to 4.02 shows that if the world holds together for a few more weeks we could see a short term move to the 4.14 level I predicted after the CC. There is no guarantee we will see this level but what I can guarantee you is that the $4.00 will be a short term level that will usher in massive short selling. Ultimately, this will lead to much lower prices in SIRI.
Blame it on Yellen, I'm just the messenger. Besides, I have a barbeque to host this afternoon. Enjoy the rest of your holiday.
The problem is two fold. People leased those cars back in 2013 and prices for the same 2016 models are up 10% during those three years. Throw in the fact that those zero financing deals are a thing of the past and new car sales are about to take a real downturn. The words sticker shock are about to rear their ugly head in the world of leases. But don't worry, the industry has a fix for lessee's who can't afford that new car smell. Since the car they now drive has depreciated 50%, they can buy it a second time, spread out the payments over 36 months and have about the same payment as when the car was new. This will reduce the glut of used cars on the market and halt the downward pressure on used car prices. It makes sense for the dealer and the buyer. As interest rates continue to rise, and Yellen seems intent on more rate hikes, the term can be extended out to 48 or 60 months to keep it within reason.
So many leases are we talking about. In 2013 about 25% of cars that were "sold" were really just rental leases. 15M cars were sold that year so put the lease fleet at 3.7M give or take. If just 10% are priced out of the market, things will get dicey pretty quickly.
This doesn't mean SIRI numbers will collapse over night. The company has 5.4M subs on trial and 24.6M self pay subs. SIRI can live off of flat sales for a while. The overall sub numbers will continue to grow, but at a slower rate than last year's 2.2M. SIRI guided to 1.6M so part of the slow down is already baked into the cake. The self pays will grow for a while because with 5.4M people that have to make a decision on the service and a 38% conversion rate the increases are built in for a couple of quarters.
The problem comes when new car sales decline in real numbers for a quarter. The subsidized subs begin to decline and the self pay follow suit. We should expect to see new car sales to be negative on a YOY basis by Sept. and that is when the PPS is likely to take a hit.
The estimates for May auto sales are out and they aren't pretty. Kelley Blue Book says sales on a YOY basis they will be down 3%. True Car says 4% while LMC Automotive goes the furthest and says 5.7%. But don't worry we are told, the drop off is all statistical. You see, May has two less selling days and if you look at the number of cars sold on a daily basis sales will be flat with 2015.
Funny, back in March when there were two selling days no one mentioned that the increase in sales was due only to the extra two selling days and that the YOY sales per day were flat. Same thing happened in April when there was one extra day and the sales per day were slightly down. No one mentioned it, except for The Duke. Now that sales will be down in May, everyone is telling you to ignore the gross number and look at the daily rate. Interesting how the story changes.
If that was the end of the story that would be bad enough, but that isn't the end of the story. Kelley Blue Book cut its 2016 sales forecast by 100,000 units only to be one upped by LMC Automotive that cut its forecast by 200,000 units. To understand what really happened, you have to look beyond the numbers in the press release. LMC automotive had predicted that auto sales would grow by 400,000 this year. Now the growth is down to 200,000 for the year. Sounds good until you realize that auto sales were up 185.000 through April 30.
So the real way to look at the cut is that LMC is saying that auto sales will be flat for the rest of the year.
The yearly changes were made a week ago but now even they are worthless.
Everything changed on FRI when Yellen made clear that it was appropriate to begin raising interest rates in either June or July. I told you earlier that the flood of leased cars would be hitting the dealer's lots this summer. It is about to start and the lessees are in for a shock. They are expecting to return the car and lease a new one. Many are in for a rude awakening.
Liberty owns about 3.2B shares. SIRI has 5B outstanding shares. That means SIRI would have to buy back another BILLION shares for Liberty to get to 80%. That would be the case if SIRI wasn't issuing new shares but it will for SXM deal and employee stock options. So figure it will take 1.1 billion shares to get to 80%. At the current rate that will take two years.
The problem is SIRI will run out of borrowed funds and have to scale back purchases. So figure about 3/4 years if all goes well. Enjoy the wait.
It was that comment that caused some of the sell off that we saw this week. There is no such thing as free press over in China so the appearance of the article on the front page was interpreted as a warning that the PBOC was rethinking its policy of flooding the market with cheap money to save its debt ridden industries from default. If you remember, markets around the world have rallied because of QE and it has been assumed that the PBOC would keep the party going through the end of the year. If they have changed their tune, there is nothing underpinning stock prices and so therefore we have a massive air pocket waiting to be filled.
Your question should be, okay Duke, but we have been this way for a while and nothing bad has happened so why will it happen this time. Actually, bad things did happen but the market recovered, so everyone has forgotten. We had the 1000 point drop in Aug and the 11% sell off in Jan. and Feb. of this year. Just a warm up for what is coming.
Here are a couple of things that occurred in financial markets in banks/credit. Italian banks dropped another 2.9% and banks on the Hang Seng were down another 2.5%. Lending Club, an incredible stupid idea, dropped 50% this week when its CEO resigned amid allegations that the credit quality of a 22M loan package had been misrepresented. Shades of what we saw in the subprime mortgage blowup back in 2007/08. Big Short 2?
The world likes to blame financial meltdowns on specific events even though the foundation for the collapse has been months in the making. Here are two possibilities for you to follow. The Brexit vote on 6/23 and a possible Yuan devaluation some weekend as the PBOC tries to help out its failing exporters. If either happens, the air pocket will get filled quickly.
The Duke will be in New Haven next weekend attending Whitney's graduation from Yale Medical School so I will see you in two weeks.
Last Aug, when SIRI announced BB4 I told you that dislocations in the subprime bond market would make it impossible for SIRI to go to the bond market to raise cash for the BB. That turned out to be accurate so SIRI tapped into its revolving line of credit to fund BB4. The first thing it did was raise its credit line from 1.5B to 1.75B with JPM. Since that time SIRI has used 600M and according to Freer on the CC had about 1.15B left as of 3/31. SIRI used 265M last Q over and above its FCF to buy back those 159M shares. So let's assume that SIRI continues to spend 90M a month over FCF and about 200M for the recapitalization. That means in 10 months or the end of Jan. 2017, the company will run out of borrowed money to fund the BB...which will be BB5 at that point. (BB4 authorization will run out in Sept/Oct 2016). SIRI's leverage ratio will be near 4 so you can forget about SIRI tapping the bond market. Basically what that means is the BB funds will reduced by 40% from 2.2B/year to 1.4B a year.
But here is the real rub. Everyone is operating under the assumption that SIRI will grow FCF forever. If you read the Duke recently, you know that I believe the credit cycle is coming to an abrupt end later this year. If you agree with me then you know that auto sales will plummet and SIRI's FCF with it. When I read about the terms on Fri, it reminded me of the XM merger that almost ended the company's existence. While we are not facing the same dire consequences this time around, my guess is that in six months we will look back at the recapitalization and say SIRI mistimed it again because they could have gotten a much better deal.
So let's continue our theme, what happened this week in the world of central banks and credit. Over in China, the PBOC shut off margin credit to speculators in commodities and that bubble died a quick death. What was worse was an article that appeared in the state People's Daily by a figure "in authority" that said growth can't come from more debt.
On the surface the deal to recapitalize the ownership structure of SiriusXM Canada and force out the retail holders makes perfect sense. It is a small company controlled by three major stockholders and retail investors get a reasonable premium. They also get a chance to invest in SIRI in lieu of cash so what is not to like?
Just a quick review of the terms so we are all on the same page. Those entities forced out the recapitalization can choose between $4.50 in Canadian dollars or about .89 shares of SIRI for every share you own in SXM Canada. Siri will fund the transaction with a total of $275M in cash and stock. The number of new shares SIRI will issue is capped at $35M and the $275M in cash will be reduced by the value of stock that is issued. Based on current figures, current shareholders would see a .0007 dilution 35M divided by 5B if the maximum number of shares are issued.
So is the deal good or bad for current SIRI shareholders? Like many things in life, the answer isn't clear cut. SIRI gets a 70% interest in the new company even though voting power will theoretically be controlled by its Canadian partners. This was done to comply with Canadian law. Certainly SIRI knows the company and supplies the product so it makes perfect sense to be in control. So on the surface the takeover makes sense.
The problem is that the timing couldn't have been worse. I can only guess at the cash and share ratio of the deal but numbers like 20-25M shares and $175-200M make sense in a combined total of $275M. That sounds cheap unless you realize SIRI is in the midst of BB4.
I know what you are thinking. Thanks for the lesson in Chinese repo rates and world trade but I didn't understand a word you said so can you say it in some words I can comprehend? Besides, all I want to do is tell you you don't know nothing so let's get this over with ASAP.
Market sell offs don't happen in a vacuum. There are usually early warning signs for the astute investors and focusing on those signs can save you a lot of money. The stress point we are facing is in the credit system so it shouldn't be surprising that the bank stocks foretell the problem. This week we saw the Japanese Bank stocks down 4.6%, Hong Kong's Banks down 5%, overall European bank stocks down 5% with Italian Bank stocks down 9%. In the US, the BKX was down 3.2%, Citi was down 4.6%, BOA down 3.4%, JPM 2.9 and GS 3.3. The S&P was down only .3%.
Early warning signs of stress in the system. I continue to believe that there is one more lurch up before the major sell off occurs. There is no particular reason why this should occur except the charts say it should happen. I predicted it would happen last year but it didn't. We will see if the charts are any better this year.
Unfortunately, that is not what happened. The banks decided to loan the money to new clients who promptly took it and invested it into the latest Chinese investment scheme, commodities. At the height of the frenzy last week, the average rebar contract was being held four hours and brokers said most of their clients had no idea how a futures contract actually worked. In the Chinese cotton futures market there were contracts traded in one day equal to the world's total production for the year. This week the PBOC stepped in to raise margin rates to cool off the market.
Back to our story. Unlike our QE program, the Chinese QE program is meant to mask massive nonperforming loans. The PBOC says NPL's are at a safe 1.6% of the outstanding debt. Most commentators think it is closer to 15 to 20% of the outstanding debt. One thing is for sure, it is higher than the official amount. We are only one third into this year and defaults in China on bonds and bank debt already exceed all of 2015.
Good story, but how does it all work. In the world of trade, everything depends on counter party risk. There is a bank on both sides of the transaction. One guarantees that the seller will ship the goods and the other that the buyer has funds to pay for goods when they arrive. Everything is fine as long as everyone trusts everyone. If banks aren't sure the guarantor bank is solvent, then the deal never gets done. This is what happens in Lehman. The repo rate in China is the rate at which banks will lend money to one another. If it spikes as it did a few weeks ago, there is fear in the system. It means banks don't trust one another and trade involving the Chinese would collapse overnight.
Last week I closed my post with a cryptic comment that said you should watch the repo rate in China and if you saw it spiking, you should think about selling out of the market. Let me explain that comment so that you can get a feel for what underlies my thought process. The stock markets in the world have generally been propelled up by an avalanche of liquidity dubbed QE. The source of this QE has been a tag team approach of the major central banks, the Fed, ECB, the BOJ and the PBOC. Each time markets were set to correct one or another of these banks has flooded the market with liquidity and kept the game going. Investors understood that the CB's had their backs and bid up stocks to the dizzying height we now have. For those of you who want to know how SIRI benefited from this, I will explain. QE depressed interest rate which let buyers get those zero rate loans helping auto sales to boom. Secondly, SIRI was able to borrow billions in the junk bond market to buy back its shares and is stupidly continuing the process with its revolver, cheered on by its shareholders who don't understand that debt ultimately kills.
Anyway, QE is much like SIRI's churn problem which might be why I brought it up in Part 1. In order to prop up the markets, central banks need to put ever increasing amounts of QE into the system to get the same effect. Finally, like a patient that becomes a immune to the medicine, QE no longer has any effect at all. That is where we are in the cycle. The BOJ and ECB tried QE expansions earlier this year and there was no response. The Fed reversed course and started to tighten and so that left the PBOC as the only CB to provide liquidity to the system.
So far it has done so, but with unintended consequences. The injections of credit were meant to be used to prop up businesses that were having trouble paying off debt. This was the 1980 Japanese model where banks were to loan more to clients to pay off interest on existing loans. Zombie loans.