Dealpolitik: Liberty Media Steps Up its Complex Dance with Sirius

John Malones Liberty Media is trying to get permission from the Federal Communications Commission to use its near majority ownership of Sirius XM Radio to take control of its board of directors. Since a tussle started in March, Sirius has opposed Liberty at the FCC and so far the FCC has rejected Liberty, basically because Liberty had not announced specific steps on its plans to effect the director election. Last week Liberty asked for reconsideration and announced some of those steps.

There is more to this dance than meets the eye. This is not about your normal struggle to control a company. Liberty has enough shares to effectively control Siriusonce the regulators give their blessing. And earlier this year, a standstill agreementwhich prohibited Liberty from trying to get more directors or otherwise control Siriusexpired.

Libertys move is probably the opening gambit in a process to harvest for Liberty shareholders the massive gain it has in its investment in Sirius. In return for loaning around half a billion dollars to Sirius when it was in dire straits during the global financial crisis, Liberty was given preferred stock convertible into 40% of the common stock of Sirius, as well as minority representation on the Sirius board.

Based on current market prices, Siriuss current market capitalization will be almost $12 billion when all those convertible securities are converted. If Liberty sold its shares now, that would be a lot of taxes to pay. And simply spinning off Sirius shares to Liberty shareholders would trigger even more taxesunless Liberty spent billions of dollars buying a lot more Sirius shares first.

But there are other transactionscomplex as they may bewhich could be used to separate Sirius from Liberty and even effect a sale of Sirius with no significant taxes. Although Sirius cannot be spun off in a tax efficient manner, Liberty could spin off its other businesses as a whole (think of it as New Liberty) and leave Sirius as pretty much the sole remaining asset of Old Liberty. And voila, Libertys shareholders have effectively received the Sirius shares without paying any taxes. And in one more wrinkle, it is possible that Sirius could be sold immediately thereafter without incurring tax as long as it was in a stock-for-stock merger. You may have read about this referred to as a Reverse Morris Trust transaction, named after an ancient tax case. Liberty has experience in this type of transaction as the DirecTV deal had some of these elements in it.

The problem is that these more complex transactions would require an extensive negotiation with the Sirius board. And because Liberty effectively controls Sirius (whether or not a majority of its directors are Liberty employees), Delaware law essentially requires Liberty to negotiate not with the full board, but with a committee of directors unrelated to Liberty.

So why is Liberty pushing so hard to get the FCC to let it grab a board majority? Because having control of a majority of the board could have significant practical implications even if Liberty couldnt cram a transaction down the boards throat. The whole dynamic of the negotiation can change once Malone has hands-on control of the company. Delaware law requires that independent directors still have the power to say no to a deal. But once Liberty has a majority of the board, it will have the power to control all other decisionsincluding what will happen if the independent directors cannot come to a deal with Liberty.

For example, the Liberty CFO appeared on CNBC last Friday and expressed support for current management. But then, in a very small shot across the bow, said that Liberty tends to make its weight known on issues relating to capital policy and that he expected Sirius to throw off a lot of cash in the future. That could be a sign that Liberty could decide to push for dividends or even a recapitalization if it does not get its way on a deal. As long as all shareholders are treated the same, Liberty could probably effect its will without the concurrence of those independent directorsonce it has a majority of the board.

At the moment it all seems to be about posturing. Liberty is trying to get itself into the best position it can to get what it will ultimately want, which is probably going to be a DirecTV type of transaction in which Liberty shareholders either receive the Liberty shares in Sirius or Sirius is sold in a tax efficient manner.

And the Sirius board has opposed Liberty so far apparently in an attempt to maximize its negotiating position.

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Dealpolitik: Liberty Media Steps Up its Complex Dance with Sirius