You would have thought that after losing the shootout to become AT&T’s direct to home satellite TV partner to rival DirecTV, Dish Networks would be on the retreat. It appears that the canny Charlie Ergen, CEO and most significant shareholder, feels that the best form of defense is attack and has been quietly buying Sirius XM Radio debt in the open market.
Right now it is likely that he could get that extremely cheaply as CEO Mel Karmazin has been telling investors that they either stump up more cash, or his business will have to fall (very cheaply) to Dish, or go into Chapter XI. The two companies are now known to have had (short) talks.
If you look down the debt instruments of the two companies, which seemingly would be under the same cosh, of falling subscriber net adds, increasing churn and rising subscriber acquisition costs caused by the recession, you will note that all the significant amounts of money that need to leave Dish will happen during and after 2011. The same view of the long term debt at Sirius would reveal that it has $572 million of currently maturing long term debt, balanced by £359 million of cash and equivalents. Right after that there is more debt waiting to be recycled or retired. It probably needs another $500 million to ensure its survival, or a better debt rating.
As mister Micawber once said’ ‘Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.’
In fact much is not as it seems at both of these companies, and lumping them in together as suffering the same concerns is both wrong and therefore misleading.
Sirius is not experiencing a rise in SAC ‘ this was almost formulaic as it is made up of costs which relate almost directly to physical costs of adding subscribers ‘ if you sell more you get charged more and vice versa.
The SAC cost of Sirius is in fact quite complex, and consists of subsidies paid to radio manufacturers and to automakers which include satellite radios in cars, but also subsidies paid for chip sets and commissions on sales. There are additional warranty obligations and an inventory allowance and some compensation costs where deals have involved stock in certain distribution agreements.
With the merger of Sirius and XM, and this was always a big part of the Karmazin plan, distribution deals could be simplified, commissions could be renegotiated since they don’t need to incentivize car makers to compete with a rival. Over time SAC was due to fall radically and during the past quarter it declined as a percent of revenue from 30.7% to 21.6%. If eventually the devices are opened to the market and they become a retail proposition ‘ something that the previous FCC was keen to see, this would fall further.
And with close on 19 million subscribers and that number rising not falling (by 344,000 last quarter) this is a business that can reach cash surpluses in one or at most two years. Lowering SAC with rising revenues make that reasonably certain. It will suffer a slowdown as car sales falter, and in this market there are no white Knights, only Sharks, and Ergen can see that without him, Sirius may not make it.
But right now the complex interplay between confidence and the scarcity of debt at reasonable prices, means that for instance when Sirius recently bought back 2.5% loan notes it had to do it with common stock, not cash or else its interest costs would have gone up and up. The potential for more debt for equity swaps of this nature makes investors rightly nervous, hence the entire Sirius market capitalization being at $386 million, and exceptionally ready for a hostile (or any other kind of) take over.
Investors would love for someone with money to come along and ensure that all the debt markers could be met going forwards, without any more need for investor pain. And then along comes Dish Networks.
We always used to wonder what investors saw in both Sirius and XM, which boasted a combined market capitalization ahead of $10 billion for most of their lives. This was at a time when the two fought it out in the market, with higher SAC costs, always loss making and always prone to a market stumble. In the early days they never even had many customers.
Now the combined quarterly loss is down to just $217 million from $265 million a year ago, and quarterly revenues are substantial at $612 million against $529 million a year ago. As we said a few more years of progress and this will dominate the US radio landscape and be a cash cow. Investors only hold it so low right now because as things stand it doesn’t have the wherewithal to make it that far.
Meanwhile the Dish market capitalization has been re-rated after the A&T deal, with the EchoStar satellite services operation down at $1.5 billion and Dish at just $6.22 billion. These are, in themselves, very much of our distressed time, and way below where Ergen has experienced them for at least the past five years.
So a cannily constructed deal that drops the Sirius assets straight in his lap might be just the thing he needs to change his own fortunes. This is not the case of two stones being tied together to see if they will float, Dish will be able to make Sirius float, and all the speculation that Ergen is actually after its orbital positions and satellite contracts, for his own Dish networks, we think, are wide of the mark.
Sure you can view this as a cheap and roundabout way of getting your hands on three big, well placed satellites, which might involve riding roughshod over subscriber quality, and forcing customers to cancel in droves, and the benefit only being felt in Dish future costs, but really we think this is more about adding more video assets to the Sirius platform, combining negotiating power between the two platforms, and seeing Sirius through to being a cash generator, than an asset strip ‘ although we have no special insights into Ergen’s mind on this and he is a brusque fellow who doesn’t really care what the world thinks, so we won’t be shocked if he has something else in mind.
For instance he may just want to be the biggest debt holder in order to allow the company to rise like a phoenix from bankruptcy with an EchoStar badge on it, or to buy out satellite assets for nothing through the same mechanism.
In any merger, the FCC may yet again decide to intervene, but if this does happen, and Sirius doesn’t find another benefactor, let’s hope that it doesn’t take two years to decide on things, given what happened last time ‘ Sirius could see that it needed a merger, by the time the FCC agreed it, so could everybody else and the remnant company became a pariah in investment circles.
To avoid all of that happening Karmazin reckons he needs $175 million now, and we reckon he might need the same again in a year or so, potentially more, perhaps as much as $500 million.
The worst outcome for Sirius is if this EchoStar interest raises investor eyebrows and they pile into the stock, only to see Ergen exit with a fat profit, selling on the debt. It’s happened before.