By Brandon Matthews

Is the media deal of the century about to take place? According to a Reuters news report, Greg Maffei of Liberty Media (LINTA) expects to “spin-off” Liberty’s preferred stake in Sirius XM Radio, which represents a 40 percent interest in the company, “at some point.”

I have been speculating about this since last April, when I first wrote about the prospects of Sirius XM Radio (SIRI) reversing the February deal with Liberty Capital (LCAPA) that staved off bankruptcy.

My suspicions began while reviewing the details of the original credit agreement between Liberty and Sirius XM, which allows for the termination of the agreement up until Dec 31, 2009. This December deadline had stuck out to me as a potential deadline that was agreed to behind closed doors.

Sirius XM Radio has gone to great lengths throughout 2009 to completely repay Liberty Capital under the terms of this agreement. The only remaining issue is what Liberty intends to do with its 40 percent preferred stake, acquired for a mere $12,500, but now valued at approximately $1 billion. With so much profit having already been attained, tax issues would seem to be a moot point, which creates endless possibilities for the disposition of the preferred shares.

When the preferred shares were issued, the price of SIRI shares dropped, as if the preferred shares were already converted to common. In other words, the current share price reflects dilution that hasn’t taken place yet. Maffei’s statement that Liberty will be looking to “spin-off” that stake makes clear that Liberty has no intention of converting those shares to common.

Although the preferred stake is worth 40 percent of Sirius XM Radio’s current market cap, the shares cannot realistically be converted and sold in the market at current market prices. The flood of shares being sold would significantly lower their price, so the preferred stake can likely be repurchased for somewhat less than its current market value.

Now that we know Liberty will seek to unwind its position in Sirius XM, this leaves only two concerns in my mind: How likely is this to occur? And where will Sirius XM get the money for such a deal?

When we look at the relationship of Sirius XM and Liberty, as it has been publicly displayed, it appears to be very good. Liberty execs Maffei and John Malone sit on Sirius XM Radio’s Board of Directors. There also appears to be a swap of executives under way. As former Direct TV (DTV) Chairman and CEO Eddie Hartenstein takes over as the chairman of Sirius XM Radio’s Board of Directors, and I suspect the just-resigned chair, Gary Parsons, will be heading over to Direct TV, which was also a Liberty holding. The relationship of these media moguls suggests that an internal deal can be reached with relative ease.

Which brings us to the point of Sirius XM Radio and its ability to pay for such a deal. Earlier in the year, shareholders approved an additional 1 billion shares to be authorized. I subsequently proposed that Sirius XM Radio could use those shares to raise the capital to repurchase Liberty’s preferred stake. According to the credit agreement which is now in effect dissolved with the repayment of the outstanding debt, Liberty would simply have to approve the sale of shares. I can find no current reason that such shares could not be issued otherwise.

Shareholder dilution is usually a bad thing for investors. In this case, though, reverse dilution would occur. There could also be a deal that involves debt and equity, further reducing the equity costs of such a transaction. Sirius XM has been advantageously repurchasing its own debt, and Liberty has been buying Sirius XM bonds this year, as well.

The effects of such a deal, if it does in fact come to fruition, would catapult Sirius XM shares to a level that would remove any reverse split or delisting fears that may exist in the marketplace. I would expect to see Liberty Media first return its stake to Liberty Capital, after which time I suspect we will see either a slow repurchase of Liberty’s preferred stake by Sirius XM Radio, or the media deal of the century. Someone will be buying that stake. It might as well be Sirius XM itself.

Position: Long SIRI

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