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Liberty SiriusXM Stock Upgraded: What You Need to Know

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

It's been 10 days since I last wrote about Sirius XM (NASDAQ: SIRI) satellite radio, and the company that owns 68.8% of its stock, Liberty SiriusXM (NASDAQ: LSXMA). In that time, Sirius stock has gained 7.1%, while Liberty SiriusXM has gained 6.5%. That's not a huge surprise, seeing as the reason I was writing about Sirius XM and Liberty SiriusXM back then was because Deutsche Bank had just upgraded both stocks to buy.

What's a bit more surprising though, is that this morning, analysts at Citibank are throwing investors a curveball, and adding yet another radio player to the mix: Pandora Media (NYSE: P).

Here's what you need to know.

Digital screen showing various tickers gaining and losing, with arrow superimposed over them
Digital screen showing various tickers gaining and losing, with arrow superimposed over them

Image source: Getty Images.

Upgrading Liberty SiriusXM

Here's the long and the short of today's news, courtesy of the ratings watchers at TheFly.com: This morning, Citigroup upgraded Liberty SiriusXM to buy and raised its price target on Liberty SiriusXM to $54 per share. Liberty SiriusXM "holds nothing other than Sirius (SIRI) shares." Yet Citi notes that those Sirius XM shares that Liberty SiriusXM owns sell for a "wide discount" to their "net asset value."

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It works like this: Sirius XM Holdings, comprising 100% of Sirius XM shares outstanding, has a market capitalization of $27.3 billion. Liberty SiriusXM, which holds 68.8% of those shares, should logically be worth at least 68.8% of Sirius XM's market capitalization. But in fact, Liberty SiriusXM's market capitalization is just 54.2% that of Sirius XM's -- $14.8 billion.

Not because of Sirius XM

Now, there are two ways to look at this disconnect in valuation. As an investor, it seems clear that if you want to own a piece of Sirius XM's business, the cheapest way to do that is to buy Liberty SiriusXM stock.

On the other hand, though, if you are Liberty SiriusXM, and want to go from your present state of 68.8% control of Sirius XM to 100%, then you have to buy expensive Sirius XM shares to do that. Which, presumably, you don't want to do.

But because of Pandora

So how does Liberty SiriusXM go about making Sirius XM stock cheaper, so as to acquire total control over the company without paying an exorbitant premium? Citigroup believes that Liberty SiriusXM is looking for ways "to close the 20% net asset value gap" by making its own shares more valuable, and/or making Sirius XM shares cheaper. In Citi's view, one way to do this might be to bulk up Liberty SiriusXM's balance sheet by buying Sirius XM competitor Pandora Media.

Citi explains: "If Liberty SiriusXM acquires Pandora, investors could be incentivized to Buy Liberty SiriusXM and Sell Sirius, which will likely cause [the valuation gap] to narrow." After buying Pandora, Citi is predicting that Liberty SiriusXM stock would rise in price, and Sirius XM would fall -- in which case it makes sense that investors should buy Liberty SiriusXM.

A third way

And that's what's happening in response to Citi's note. As of 11:30 a.m. EST, Sirius XM stock is down nearly 0.5%, while Liberty SiriusXM is up a good 0.8% or so. But -- alert readers may already have predicted this -- there's a third effect of Citi's upgrade today: Pandora stock is hopping 3% higher on hopes that Citi is right and Pandora is about to get bought out.

Is that the right call? Maybe, but also maybe not. Unlike Sirius XM and Liberty SiriusXM, Pandora stock is unprofitable. In fact, data from S&P Global Market Intelligence show that Pandora has never been profitable, and it's become steadily more un-profitable for five years straight. Pandora lost $564 million over the past 12 reported months -- 20 times more than it was losing five years ago.

It's certainly possible that Citi is right, and investors would value a combined Pandora/Liberty SiriusXM more highly than Liberty SiriusXM alone. Still, I have to wonder if the opposite might be true -- if investors might balk at the prospect of seeing their Sirius profits dinged by being paired with unprofitable Pandora.

In that case, investors buying Liberty SiriusXM and selling Sirius XM today might be making exactly the wrong move.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Pandora Media. The Motley Fool has a disclosure policy.