Despite the intense public focus on the potential deal between Twitter and Elon Musk, the market seems to have missed a key, developing risk.
On April 14th, Elon Musk disclosed a formal offer to take Twitter private. Twitter’s board examined other options and reportedly considered soliciting other offers, but better competing bids failed to materialize.
After expressing some very brief but very strong hesitation, the board accepted the offer almost immediately, underscoring how Musk’s offer was vastly superior to alternatives for Twitter, including remaining a publicly traded company.
Since the day before Musk disclosed his initial stake in Twitter, multiple developments have weakened the company’s position, threatening the current deal dynamic.
As a result of these developments, we believe that if Elon Musk’s bid for Twitter disappeared tomorrow, Twitter’s equity would fall by 50% from current levels. Consequently, we see a significant risk that the deal gets repriced lower.
The key developments that have occurred since Musk’s initial stake include:
Musk’s disclosure of his initial Twitter position preceded a broad meltdown in tech stocks. As of this writing, the Nasdaq composite has plummeted ~17.6% since the closing price prior to Musk’s disclosure of his initial 9.2% stake on April 4th.
Twitter has outperformed the Nasdaq by ~43% since Musk disclosed his initial position, setting the stock up for a material downside reversion should Musk walk away from the deal.
Beyond broader market dynamics, Twitter’s recent reported performance represents further downside that hasn’t been priced into the stock – but would be, in a scenario where Musk’s offer doesn’t consummate.
Twitter announced it had accepted Musk’s bid on April 25th. Just 3 days later, it reported weak earnings, disclosing (i) its slowest revenue growth in six quarters, which missed estimates, and (ii) an overstatement of its daily active user count.
Twitter acknowledged overcounting about 1.9 million global users in Q4 2021, roughly 0.88% of its total user base. This admission comes barely 4 months after Twitter’s recent $809 million securities fraud settlement over past issues relating to overstatement of users.
We suspect that Twitter continues to overstate its true daily active users, despite the revision. As indicated by Musk, the platform is flooded with bots, spam, and scam accounts that likely inflate its genuine user metrics even further.
Musk has made it clear to Twitter’s board that should the deal not consummate, he will sell his shares.
“This is binary – my offer will either be accepted or I will exit my position,” Musk wrote to Twitter’s board on April 24.
This could create further downside pressure on a stock that we already believe is due to be re-rated significantly lower.
Some market observers have debated whether Musk can simply walk away from the deal by paying the $1 billion breakup fee.
The debate centers around a “specific performance” clause in the merger agreement, which gives Twitter the right to force Musk to close the deal as long as he has the available financing. [Pg. 70]
Historically, these challenges are rarely enforced. Given that Musk has direct influence on the financing and no apparent fear of a court battle, the possibility of this clause being enforced successfully seems incredibly remote.
In sum, we believe Musk could walk away from the deal for a $1 billion breakup fee. Given the above collective dynamic, Musk has incredible leverage to renegotiate should he choose to.
Musk has said of the transaction: “I don’t care about the economics at all”, leading many to believe the current offer price is set in stone.
We are supportive of Musk’s efforts to take the company private, and believe he could get it done, but see no reason why he should at these levels.
Reuters has estimated leverage on the proposed Twitter deal to be at a nosebleed 8.6 times EBITDA. As one analyst cited by the Wall Street Journal noted, “The deal has been structured to have as much leverage as possible”.
The heavy debt load would make it more challenging to pursue Musk’s goal of reducing Twitter’s reliance on advertising, which currently comprises the vast majority of its revenue. [Pg. 53]
According to investment bank Cowen, the current deal for Twitter envisions an equity commitment of $20.1 billion from Musk and $7.1 billion from other investors with the remaining $19.25 billion set to be funded through debt.
Musk recently lowered the margin debt portion through new equity commitments, but a financing gap of about $13.9 billion in equity and margin debt has yet to be filled.
Twitter’s board owns less than 0.2% of Twitter’s equity, aside from Jack Dorsey’s ~2.4% stake.
Dorsey’s position on rolling his equity or cashing out remains vague. Key holder Prince Alwaleed bin Talal of Saudi Arabia intends to roll his ~4.6% equity stake. Any party rolling (or contributing) equity would prefer a lower price with lower commensurate debt, given that their equity stake will remain static regardless.
A lower deal price with less excessive leverage will place both Twitter and Tesla on more solid financial footing.
Musk has already sold ~$8.4 billion in Tesla shares to help raise capital for his Twitter bid. These sales, which came mostly on Tuesday, April 26, 2022, contributed to Tesla falling 12% during the day’s trading session. As of this morning, Tesla is lower by ~19% since the trading day before Musk’s recent Tesla share sales.
Note that Musk previously pledged about 88.3 million Tesla shares as collateral for loans, according to Tesla’s filings prior to the Twitter bid.
Placing both Twitter (and ultimately Tesla’s) future on a foundation of further equity-backed margin loans, or potentially more sales of Tesla equity amidst a volatile market, adds risk to both enterprises.
Twitter is currently trading at about a ~10% discount to its current proposed go-private price of $54.20. We view the risk of a higher competing offer as extremely low, essentially capping the downside on a short at these levels.
There seems to be no credible risk from an anti-trust perspective, but the deal is still subject to risk of delay given the intensity of the political backdrop.
In our view, Musk holds all the cards here. The board quickly agreed to the deal when conditions were vastly more favorable, and we think they’d make the right decision again when faced with the present reality.
We agree with Elon Musk that Twitter has become the de facto public square. We also agree that the pressures of being a public company make it harder to advance the mission of Twitter serving as an open, trusted forum for diverse ideas.
Twitter has played a key role in democratizing financial research, a field that large Wall Street banks monopolized for decades.
We are grateful to have an open forum to share our research, which has largely focused on exposing market fraud, such as:
To date, we think Twitter has fallen short in managing the admittedly difficult balance between user safety and being an open, trusted forum for diverse ideas. Overall, we are supportive of Musk’s efforts to take Twitter private and see a significant chance the deal will close at a lower price.
Best of luck to all.
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