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Sirius Missed Royal Flush


Convertible move last year could have averted bankruptcy crisis.

While Sirius XM's (SIRI) penny-stock price has attracted most of the general attention, the real drama has surrounded the company's convertible bonds.

During the big growth phase of 5 years ago, both Sirius and XM were raising money largely through the convertible-bond market. The bonds that triggered today's near-bankruptcy came to market at the same time, when Sirius common was around $3. Later in 2004, the stock became one of the leading toys for day-traders, running briefly above $9 as it was benefitting from the hype of Howard Stern, Mel Karmazin and becoming part, if memory serves, of the S&P 500.

Sirius XM could have avoided today's confrontation while the stock was running by doing what's known as a "flush-out." This involves offering convertible holders a moderate increase in the conversion ratio if the holders agree to convert the bonds immediately.

Such a strategy works when a stock has performed very well and the convertibles are trading only marginally above their pure stock value. It's a great way for a company to take advantage of its popular stock to solidify its balance sheet, and prepare in advance for times such as these by removing potential liabilities -- such as convertibles -- coming due at the cost of modest dilution. Dilution was particularly irrelevant to Sirius, which has never made a profit.

Assuming we get out of this period -- and we will, though I won't say when or where -- companies should remember this kind of lesson.

A very interesting little piece of paper now is Sirius XM's next major debt obligation: a convertible originally issued with a 1.75% coupon in late 2004. Last year, the merging companies agreed to raise the coupon to 10% to get bondholders not to stand in the way of the merger - a right the holders may have had because of some faulty language in the bond indenture. Many holders thought the company's interests would have been better served by increasing the conversion ratio -- thereby effectively issuing equity -- instead of leaving the debt obligation outstanding.

These bonds were trading recently below $0.40 on the dollar. With today's official announcement of Liberty Media's (LCAPB) involvement, they're now around 75. If you believe Liberty's in it for the long haul and won't let Sirius go under later this year, they're still very attractive because of the big coupon, short maturity and vastly improved implied credit quality.

Of course, Liberty could decide to walk away. The issue size was originally $400 million, but about $172 million was extended for 2 years last week. If Liberty sticks with the investment through 2011, the holders who extended the maturity will clip a big coupon for a nice period.

The bottom line, though, is that Sirius could have avoided all this back in 2004 with a flush-out for minimal, and meaningless, dilution. Mel Karmazin has made a lot of good moves in his career, but he took his eye off the ball on this one.
Position in SIRI

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