Warren Buffett’s newest arbitrage opportunity will undergo a one-time stock split in less than 2 weeks

For the better part of six decades, Berkshire Hathaway (BRK.A 0.83%) (BRK.B 0.81%) CEO Warren Buffett held a master class on investing for Wall Street. During his tenure as head of Berkshire, he oversaw a total gain of nearly 5,500,000% in his company’s Class A shares (BRK.A) and nearly doubled the annualized total return, including dividends, of the benchmark. S&P 500.

Considering how well the “Oracle of Omaha” has done in terms of investing, it’s no surprise that investors tend to mirror his trades and traits to increase their fortunes. Some of Buffett’s best-known investing traits include his desire to hold stakes in great companies for long periods, as well as his tendency to acquire businesses with well-defined competitive advantages and strong management teams.

Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.

But what might come as a shock is that what Warren Buffett advises long-term investors to do — namely, stay the course and bet on America’s long-term success — and what he and most his good assistants in investing (Ted Weschler and Todd Combs) is done for shorter periods, it does not always merge.

For example, even though Buffett has repeatedly opined that investors should not bet against America, he and his investing lieutenants have been net sellers of stocks for seven consecutive quarters.

Furthermore, Buffett doesn’t always have the long term in mind when he puts his money to work on Wall Street.

Warren Buffett occasionally deals with arbitrage opportunities

While Weschler and Combs are known to be a bit more active on the business front than Buffett and former right-hand man Charlie Munger ever were — Munger died at age 99 in November — the Oracle of Omaha does, on rare occasions. time, interfere in arbitrage opportunities.

For example, Buffett oversaw an increase in Berkshire’s stake in gaming company Activision Blizzard in early 2022 to more than 9%, shortly after Microsoft (NASDAQ: MSFT) offered to buy the company for $95 per share in an all-cash deal.

There have certainly been some regulatory hurdles for this combination that have played out over the course of more than a year. However, the uncertainties of this deal were more than reflected in Activision Blizzard’s share price trading well below (more than 20% below, in some cases) Microsoft’s cash offer. Microsoft finally got the approvals it needed and completed its acquisition of Activision in October 2023.

While Warren Buffett hasn’t specifically stated that it’s an arbitrage opportunity, there’s a pretty good chance that the buying activity we’ve witnessed by Berkshire’s investment trio in the satellite radio operator. Sirius XM Holdings (SIR 0.62%) and Liberty Media’s Sirius XM tracking stock, Sirius XM Liberty Group (LSXMA 0.13%) (LSXMB 4.58%) (LSXMK 0.39%), it is related to arbitration. Berkshire Hathaway has holdings in Class A (LSXMA) and Class C (LSXMK) shares of the tracking stock.

In December 2023, Liberty Sirius XM Group and Sirius XM Holdings announced their intention to merge into one company and create a unified share class. The exchange ratio of Liberty Sirius XM Group shares to Sirius XM Holdings shares is calculated “based on (1) the number of shares of Sirius XM owned by Liberty, reduced by a net adjustment of liabilities shares, divided by (2) the number of shares of the adjusted fully diluted shares of Liberty Sirius XM Group.”

Although this final exchange ratio will not be determined until September 5, it was approximately 8.4 shares of Sirius XM for each Liberty Sirius XM Group share when the merger to create a class of shares was first announced .

As of the closing bell on Aug. 23, shares of Liberty Sirius XM Group were valued at what appears to be a notable discount to Sirius XM Holdings, based on the initial exchange report. This means that we could see a convergence of the two stocks, with Liberty Sirius XM Group rising in value and Sirius XM falling in price, or perhaps a single stock accounting for most of the valuation gap by going up or down . Given that Berkshire owns more than $2.4 billion in Liberty Sirius XM Group stock, compared to $425 million in Sirius XM, Buffett and his team apparently see this as a clear arbitrage opportunity.

Image source: Getty Images.

Buffett’s latest arbitrage bet is set to undergo a one-time stock split

To make matters even more interesting, this new singular class of Sirius XM will perform a reverse stock split after the merger is completed.

A stock split is a tool that allows publicly traded companies to change their stock price and number of shares outstanding by the same factor. The spin-off has no impact on a company’s market capitalization or underlying operating performance.

With a reverse split, a company’s objective is to increase its stock price and reduce the number of shares outstanding by the same magnitude. Based on a June 17 filing with the Securities and Exchange Commission, Sirius XM plans to conduct a 1-for-10 reverse split, which is expected to become effective after the close of trading on September 9.

Reverse splits themselves are not unique. We see these happening regularly with struggling companies hoping to avoid delisting from a major stock exchange.

What makes Sirius XM’s upcoming reverse stock split so unique is that it’s not in danger of being pulled. The only reason the company is doing a reverse split is because it ended the June quarter with about 3.85 billion shares outstanding. With its share price in the low single digits due to its large number of shares outstanding, some institutional investors may stay away or find the low share price too risky. A reverse split solves this relatively minor problem. It’s a rare case where a reverse split shouldn’t worry investors at all.

And in the unlikely event that this isn’t somehow an arbitrage bet by Warren Buffett and his investment team, Sirius XM absolutely brings clear competitive advantages and an attractive valuation to the table.

Sirius XM is the only licensed satellite radio operator, which gives the company some degree of pricing power with its subscribers. Following recent subscription price increases from Spotify technologythe door is wide open for Sirius XM to raise its prices.

However, Sirius XM’s most significant competitive advantage might just be how it generates its revenue. While most online and terrestrial radio providers rely heavily on advertising for the majority of their revenue, Sirius XM brings in less than 20% of its sales from advertising.

Most (77%) of its net sales come from subscriptions. Businesses are more likely to cut advertising spending during tough economic times than Sirius XM subscribers are to cancel their service. This results in a more stable and predictable operating cash flow for Sirius XM compared to its online and terrestrial rivals.

Sirius XM stock is also historically cheap in a very expensive stock market. While the stock market has only been this expensive on a handful of occasions, dating back to the early 1870s, Sirius XM is valued at just 10 times estimated 2025 earnings per share. That equates to a 44% discount to the multiple expected earnings environment. over the past five years and exemplifies why Sirius XM could be a perfect long-term holding for Warren Buffett.