Shorting Sirius

I said in a November 11th post about the coming of HD radio that I would not buy Sirius at its current price and that I’d rather buy Clear Channel.

Had anyone done what I suggested, they’d be out some money. Clear Channel (CCU) closed at $33.92 on Nov 11th.  If you’d bought it then, you’d be down $0.53/share right now.  Not a terrible loss, but not a money making experience either.

Sirius (SIRI), on the other hand, has been an incredible money maker in the past month.  It closed at $3.85/share on Nov 11th.  Yesterday, it closed at $6.90/share, but it has traded as high as $9/share in recent days.

That’s the problem with fundamental analysis and trading stocks.  The two aren’t often complimentary skills. Certainly they are not complimentary in the short run.  And that’s why I’ve never been particularly good at playing the public markets.  We now leave that to the pros with our real money and we sometimes dabble a bit here and there.  But rarely on the short side.

With that said, I am going to propose a hedged trade.  Go long CCU at $33.92 and go short SIRI at $6.90.

Clear Channel’s got a market cap of $19bn, they own a huge piece of the terrestrial broadcast radio industry and a lot of outdoor and live music related businesses.  They trade at 11 times trailing cash flow (as represented by EBITDA).  That is a discount to the price that radio stations are selling at privately in the M&A market.  Based on fundamentals, Clear Channel is a buy.  Buying CCU right now is also a bet that terrestrial radio has a future in the digital world.  And that is where HD Radio comes into this.  It’s a bet that as terrestrial radio goes digital, the broadcasters, CCU included, will use the new technology to offer a better experience for listeners and advertisers.  It’s also a bet that the device manufacturers, recievers, cell phones, digital music players, PCs, etc will find a way to integrate the radio experience into their digital devices.

Sirius has a market cap of $8.7bn.  They don’t have any cash flow.  Just a lot of promise.  So much promise (aka hype) that as of yesterday, they were being valued at as if they already had 45 million subscribers, according to this incredibly bearish piece by Jesse Eisinger in the Wall Street Journal.  Jesse is a pro, he used to work at TheStreet.com and I’ve read a lot of his stuff.  He’s dead right about this one.

I never like to buy stocks without a target, so I am going to put some target prices on this trade. 

I expect that within a year, CCU will trade at least at 15x EBITDA which is where a diversified media company like Time Warner or Disney trades at.  This should happen as the market discovers that terrestrial radio isn’t dead after all. The street thinks earnings will rise about 15% next year, so with the multiple expansion and earnings growth, I think CCU stock should be at $50/share by the end of next year.  It was almost there at the beginning of this year, so in many ways this is also a value bet.

Sirius on the other hand has nowhere to go but down.  Someday it will be valued on subs.  And a sub is worth $350 to Sirius, according to Jesse Eisinger.  So let’s say that Sirius triples it subscribers next year to 2.5mm.  At $350/sub, that’s less than a billion dollars of market cap.  Let’s say that all of the 8.5mm weekly Stern listeners become Sirius subscribers by the end of next year (which is a ridiculous assumption), then that’s about $3 billion of market cap.  I’ll predict it ends up somewhere in between, say $2 billion of market cap by the end of next year.  With 1.26bn shares outstanding (yes, you read that right), that’s a stock price of $1.60/share.

So if I was going to make this trade (and I am not for several reasons unlrelated to the economics involved), this is what I’d do.

I’ll buy $500 of CCU today and go long 15 shares.  If it trades to $50 like I think it should, I’ll get $750 when I sell at the end of next year.  I’ll get the $500 to buy CCU by shorting 75 shares of SIRI. If it trades down to $1.60/share by the end of next year, I’ll have to spend $120 to buy the stock back.  I’ll fund that $120 out of my $750 in proceeds from the sale of CCU.  And I’ll take $630 to the bank.  I sure hope it works out that way!

UPDATE:  My friend Seth Goldstein who started Majestic Research, which is hosting their annual Internet conference today, rightly pointed out that this post needs a disclosure.  So here it is.  I am an investor in and director of iBiquity Digital, the developer of the HD Radio technology.