The Bird is Freed

Musk buys Twitter. Time to take cover?

So it has finally happened. Elon Musk has purchased Twitter, in what may be the strangest M&A transaction in my professional lifetime. Over a very short period of time, Musk went from being simply a large and active user of Twitter to the controlling shareholder of the company. In the process he shelled out $44 billion, more than half of which was his own money, to buy a company he often disparaged and seemingly did not really want to own. How exactly did this strange result come to be? What should we expect to happen next? And what if any lessons might we learn from this somewhat out-of-body experience?

Let’s explore.

Transaction recap. If you are like me, you still wake up in the middle of the night with your heart racing from a nightmare that you are Elon Musk’s lead banker (or lawyer) on the Twitter deal. Once awake, however, you sigh with relief that this was just a dream and nothing like this could possibly happen in the real world. But it did, and some of the details are simply beyond belief. For those of you who have not been following the deal closely, I have provided below a summary recap that you may find informative and possibly even amusing. Others of you may want to skim this section, and thank your lucky stars that you don’t work on the Musk-Twitter team at Morgan Stanley. If you do happen to work on that team at Morgan Stanley, you’ve been through a lot and we all wish you a speedy recovery. Sorry about your bonus this coming year, but thanks for the entertainment.

This transaction began back in March, when Musk surfaced unexpectedly as the owner of 10% of Twitter’s shares, purchased quietly on the stock market (and apparently in contravention of SEC disclosure regulations). Once Musk’s ownership became public, the Twitter board deliberated and decided to offer Musk a board seat, perhaps concluding that it would be better to have Elon inside the board tent pissing out than outside the tent pissing in, which he is wont to do. Musk initially accepted the offer of a board seat but quickly reversed his decision, perhaps after his lawyers reminded him of the obligations and constraints associated with serving on a public company board. Which Musk as a long-time public company board member (and former chairman of Tesla) should have understood before saying yes in the first place.

Shortly after declining the Twitter board position, Musk made an unsolicited and unexpected all-cash offer to buy the entire company, on April 14th. In true Musk fashion, the offer was delivered by tweet. The price he offered, $54.20 per share, was apparently determined in part as a weed joke (the ubiquitous Musk ‘420’), and more than one person has suggested that Musk might have been high when he made the offer. But whatever the level of THC in Musk’s bloodstream, the offer price represented a generous premium to the market price of Twitter’s shares, which were then trading in the mid-30’s. The Musk offer price translated into a transaction value of around $44 billion, to be funded entirely with cash, which Musk did not then have.

At the time Musk made his offer, the digital advertising market was just beginning to show signs of softening but the stock market was already pricing downward the shares of other ad-driven companies. Once Musk’s offer became public, however, the price of Twitter shares rose to $50 a share, a relatively small discount to the offer price, suggesting that the stock market took Musk’s offer quite seriously even if the Company and many observers were not entirely sure what to make of it.

Twitter’s bankers quickly shopped the company to other potential bidders and found no serious interest other than Musk’s. After further deliberation, Twitter’s board decided to accept Musk’s offer. But it did so only after Musk agreed to several important concessions. Musk agreed to defer and narrow substantially the scope of his due diligence, to drop his financing contingency, to personally guarantee several key merger agreement provisions relating to funding, and to grant Twitter the contractual right to court-ordered specific performance in the event of a breach by Musk, a concession which ultimately proved critical to the future course of events. And so the deal was agreed and publicly announced on April 25th.

Following the signing of the merger agreement, Twitter shares continued to trade at prices above $50, but not for long. With the digital advertising market in full retreat and the share prices of other social media companies plummeting, Musk quickly developed a rather serious case of buyer’s remorse and began searching desperately for some way to extricate himself from his ill-considered (or at least ill-timed) commitment to buy Twitter. Musk began aggressively and very publicly disparaging Twitter and its management team, seemingly in violation of his obligations under the merger agreement but in any event a rather odd thing to do for the soon-to-be owner of the company. Musk and his lawyers ginned up a number of blatantly pretextual allegations of contractual breaches by Twitter, including the so-called ‘bots’ issue which we all read so much about at the time. By mid-May, when Musk unilaterally declared the merger to be ‘on hold’, the Twitter stock price had fallen back into the mid-30’s and the probability of this deal ever closing seemed quite low.

It was not until July, however, that Musk’s lawyers informed Twitter that their client was in fact terminating the merger agreement, citing the bots issue and several other alleged breaches of the merger agreement by Twitter. The Twitter board was not amused by this turn of events and the Company immediately sued Musk in the Chancery Court of Delaware, where Twitter is incorporated, seeking a court order of specific performance which would force Musk to close the deal on the agreed terms.

An expedited trial was scheduled for mid-October, but as the trial date (and Musk’s testimony) drew near Musk surprised everyone (including perhaps his own lawyers) by reversing course once again and announcing that he was prepared to close the deal on the originally agreed terms. (At the time, Musk and Twitter had apparently been in confidential settlement negotiations.) The judge delayed the start of the trial to allow Musk to firm up his financing, with a closing deadline set for October 28th, which the parties worked hard and successfully to meet.

And so it is that Elon Musk came to own Twitter.

Musk’s financing. On October 28, Twitter shareholders received $54.20 in cash for every share they owned previously. Twitter’s shares were delisted from the stock exchange and no longer trade publicly. Elon Musk and his co-investors now own Twitter, for which they effectively paid $44 billion in cash. The purchase was funded with $13 billion of non-recourse debt provided by a small group of banks led by Morgan Stanley plus $31 billion of equity, over 80% of which came from Musk personally. Musk raised his share of the cash largely from the sale of Tesla stock, after deciding not to take down a margin loan (secured by Tesla shares) which his bankers had previously agreed to provide. Musk’s financing banks have been unable or unwilling to syndicate any of the debt they underwrote and are collectively sitting on unrealized losses estimated at $500+ million (potentially a lot more) as a result of big increases in junk bond yields since the time the banks priced their initial commitments. Meanwhile Musk and his co-investors are sitting on unrealized losses totaling as much as $20 billion, all from the purchase of a company they almost certainly wish they did not own today.

Post-closing events. Musk’s acquisition of Twitter only closed this past Friday, but a lot has happened since then. Immediately after closing the deal, Musk changed his Twitter bio to “Chief Twit”, a label which seems oddly appropriate given his erratic personal behavior over the past few months. He also tweeted to his 100 million or so followers (bots included) “the bird is freed” and “let the good times roll”.

Meanwhile at the Company, it was heads not good times that were rolling as Musk replaced the entire board of directors (with himself as the sole director) and began purging the Twitter senior management team. On his first day as the new owner, Musk fired the Twitter CEO, CFO and several other senior executives, who are likely delighted not to have to deal any longer with the Chief Twit and who will walk away with over $100 million of golden parachute payments to tide them over while they lick their wounds. Twitter’s other 7500 employees, who do not have parachutes, likely spent this past weekend praying fervently that Musk would not eject them from the plane too, or at least not until their deferred comp vests on November 1 (tomorrow). As I write, however, the press is reporting that Musk’s henchmen spent the weekend at Twitter finalizing plans to fire 25% or more of the Twitter work force, to be announced shortly.

And while all of this was going on at the Company’s HQ, Twitter users continued to ‘debate’ online the merits of Elon Musk taking control, with Republican and Democratic politicians piling on and throwing even more fuel on the fire in the run-up to the mid-term elections. Donald Trump has made clear that he expects to get back on Twitter with no constraints, not that he really wants or needs to be on Twitter mind you. Several Russian and Chinese state-owned media companies began lobbying to have the ‘propaganda’ warning label removed from their tweets. And racist, anti-semitic and violent tweets are reportedly surging (much of it allegedly generated by trolls), reminding us once again of the central role played in our nation’s raging culture wars by social media generally and Twitter in particular. And of course the importance of getting Twitter’s bots under control.

Several large advertisers have indicated that they will hold off making new commitments to Twitter pending further clarity on Musk’s plans for content moderation. In response to these concerns, Musk on Friday sent out a very thoughtful and even diplomatic note to the digital advertising community, stating that under his leadership Twitter would become “the most respected advertising platform in the world”, a place that is “warm and welcoming to all”, and not a “free-for-all Hellscape". Unfortunately, however, the integrity of this seemingly responsible and reassuring message was quickly called into serious question after Musk himself on Sunday retweeted a link to right-wing conspiracy misinformation regarding the Paul Pelosi attack. Musk took down his own tweet a few hours later, but by then the damage had been done.

Why did Elon Musk want to buy Twitter in the first place? This is a great question. Elon Musk has for a very long time been a super-active Twitter user, with a reported 100 million or so followers (bots included). According to a Washington Post analysis, Musk has tweeted over 19,000 times since joining Twitter 13 years ago, an average of more than six tweets a day (and multiples of that on some days). As Musk himself said in March 2019, “Some people use their hair to express themselves, I use Twitter.” This is a sentiment which I cannot personally relate to, on either count, but it does raise the question of why Musk wanted to buy Twitter rather than just remain an active user free to post whatever ill-considered ‘thoughts’ came into his mind at all hours of the day and night.

The answer seems to have much to do with Musk’s personal ‘libertarian’ political beliefs, which he freely acknowledges and actively promotes. Musk has said publicly on several occasions that he thinks it is ‘critical to the future of civilization’ that Twitter remains (or becomes) a largely unregulated ‘common digital square’ open to all points of view however misguided, untrue or hurtful. But what kind of ‘civilization’ does Musk have in mind? Well, in February 2017, Musk tweeted that “Twitter is a hater Hellscape", which he may not have intended as a criticism. In October 2018 he posted that on Twitter “likes are rare & criticism is brutal. So hardcore. It's great.” And it seems clear from his own tweets that Musk was not at all happy with Twitter’s recent content moderation moves, particularly since the events of January 6th, which he believes have made Twitter a less effective social media platform and frankly less fun for people like him.

But did Musk have to buy the company in order to implement these desired changes? Probably not, given his high profile, rock star reputation and wide following. Instead of buying the company, Musk might have been able successfully to lobby Twitter to change its content moderation policies and other aspects of its operating model either from the outside (particularly with his initial 10% ownership stake) or from the inside by joining the Twitter the board. Without buying more shares, Musk might even have been able to leverage his influence into a role as Twitter’s board chair, a position he used to hold at Tesla (in addition to the CEO role) until forced to step down to settle securities fraud charges filed by the SEC. (Remember Musk’s now infamous ‘planning to take Tesla private, $420 a share, funding secured’ tweets?)

Of course buying all of Twitter gives Musk a much greater degree of control over the future of the Company and allows him to make the desired changes more quickly than would otherwise have been the case, with as much or as little third party input and advice as he cares to solicit or receive. But in light of the past few days’ events, one must question whether this is really the case.

How much control will Musk actually have over Twitter? It is unclear to me exactly what portion of Twitter’s shares will be owned or controlled directly or indirectly by Musk personally, but we can safely assume it will be a large majority (over 80%) and likely structured to give him more or less unfettered corporate governance control even if he at some point sells down his economic stake. (This is the case at Facebook and many other similar companies.) As for Musk’s co-investors, it is not entirely clear how much they own of what form(s) of security, or what economic and governance rights they may have. But I think it is fair to assume that Musk personally will be in effective control of Twitter going forward and that his co-investors will have to resign themselves largely to going along for the ride, at least initially. As for Twitter’s banks and other lenders, their influence will be limited as long as Twitter is able to service its mandatory debt payments and remains in compliance with any debt covenants (which I suspect are minimal). But how long this situation lasts is anyone’s guess, particularly given the substantial financial pressure which the now highly leveraged Twitter is likely to experience over the coming years.

Even as a Musk-controlled private company, however, Twitter must still find a way to satisfy the often conflicting desires of users, advertisers, employees and other important constituencies, which will limit Musk’s ability to do whatever he wants with the company. Twitter must also comply with applicable laws in all the jurisdictions where it has operations (or users), and this may prove to be substantially more difficult to do than Musk has previously understood. Shortly after Mr. Musk’s “the bird is freed” tweet, the EU tweeted in reply “In Europe, the bird will fly by our rules”. Which seems like a timely reminder that corporate ‘control’ involves more than share ownership, voting rights or board seats, however big the owner’s ego and however much money or how many followers he may have.

How does Musk plan to make money on this deal? Must says that he doesn’t care about making money at Twitter and that his motivation for buying the company is entirely non-commercial. Or at least he says this sometimes, but not consistently. He has also talked about unlocking the huge untapped economic value of Twitter, which he describes as ‘magnitudes greater than its current value’. But whatever Musk’s true motivations, and whatever his sense of value potential, it is fair to assume that his lenders and co-investors do care (a lot) about making money for both Twitter and themselves. And they will not be shy about expressing their views and voting with their pocketbooks as and when they can.

It seems clear that Musk has a lot of work to do if he hopes to make Twitter profitable and generate attractive financial returns for himself and his co-investors. Twitter’s current annual revenues run at around $5 billion, with gross profits of around $2 billion, but the Company loses about $1 billion a year at the operating profit level. From a cash-flow perspective, non-cash share-based compensation expense was running this year at around $1 billion a year, and Twitter will have to find new ways to compensate employees now that its shares are no longer publicly listed, presumably with more cash (and likely fewer employees). Twitter’s annual interest expose bill is set to increase by about $1 billion as a result of the $13 billion of debt incurred in the acquisition, and the principal amount will have to be paid off or refinanced over time. (I don’t know what the maturity schedule looks like.) All of which does not leave a lot of room for Musk to maneuver financially, particularly in a deteriorating advertising and macro-economic environment.

And so the financial picture at Twitter does not look at all good, even for a purported miracle worker like Elon Musk. But of course Musk and his financial supporters are all smart and financially savvy professionals who generally know what they are doing. And so we should probably assume that they all went into this deal with their eyes more or less wide open, with or without a credible plan for making the numbers work.

As a private company, Twitter’s financial results will no longer be publicly reported, which will limit how much we know in the future about the company’s performance. This should also make it easier for Twitter to make some hard financial decisions, a common rationale for taking public companies private. But hiding problems from public view does not make them go away, and Twitter’s lenders and other shareholders will no doubt be paying close attention.

From a societal perspective, is it a good or bad thing that Musk is taking over Twitter? As should be clear by now, I am not a big fan of Elon Musk, for many reasons. What concerns me most in this context however is Musk’s repeated demonstration of bad judgment (if not bad faith) on a variety of important and sensitive matters, both at Twitter and at Tesla. Musk has regularly thumbed his nose at the public authorities and flouted the laws and customs that govern the rest of us mere mortals. And so you might expect me to say that Musk taking over Twitter is really a horrible thing from a societal perspective and that operating Twitter as a private company will unleash Musk from what few constraints he now feels personally encumbered by. With Musk buying Twitter, not only will the bird be freed but so will Elon, with who knows what in the way of social consequences.

These are not unreasonable concerns, but I think they may be somewhat overblown. Even as a private company, Twitter must still comply with all applicable laws in the jurisdictions where it operates, as the EU so cogently reminded Twitter’s new owner. And this is a warning that Musk should take to heart, however disparaging he may be personally of government regulators and ‘woke’ politicians. If Musk decides to make radical changes at Twitter, particularly in the area of content moderation, it may backfire not only with regulators but also with users, advertisers, employees or other constituencies whose continued support Musk needs to retain if Twitter is to remain viable, let alone become valuable.

Do I love the idea of billionaire ego-maniacs like Musk taking personal control of large socially sensitive organizations like Twitter? No, I do not. But I am not entirely convinced that having individuals like Musk (or for that matter Bezos, Zuckerberg or Murdoch) in control of media and communication companies is necessarily any worse than some of the alternatives. Widely held public companies can also operate irresponsibly and with relatively ineffective corporate governance mechanisms to boot. And I don’t at all like the idea of government controlling (or over-regulating) these companies and turning them effectively into arms of the state (or worse of the party in power). We have a lot of pressing social and political problems here in the USA, which social media activity often seems to aggravate, but we are not in the same boat as Russia or China. At least not yet.

My predictions? My crystal ball is particularly cloudy at the moment and I really have no idea how things will play out at Twitter under Musk’s ownership. Elon Musk’s purchase of Twitter may prove to be a truly brilliant move, which establishes Twitter’s critical and constructive place in our society for decades to come and makes Elon and his co-investors even more money than they already have and don’t need. Alternatively, it may turn out to be a complete disaster and the beginning of the end of the Elon-Musk-walks-on-water phenomenon, and potentially of our democracy. Or more likely something in between. I really don’t know.

But what I do know is that the Twitter story is far from over and with Elon in charge it will continue to be ‘interesting’ to say the least. The Twitter bird has indeed been freed, and so has Elon, so it’s probably a good time for all of us to cover our heads.

Links

Can Elon Musk Make the Math Work on Twitter? It’s Dicey, NY Times, October 30, 2022

Musk Takes Twitter Helm as Social Media Sputters, WSJ, October 29, 2022

Musk Moves Quickly to Put Imprint on Twitter, WSJ, October 28, 2022

The Musk-Twitter Timeline, WSJ, October 28, 2022

Musk Buys Twitter: Live Updates, NY Times, October 28, 2022

Musk Takes Twitter and Tech Deals to New Level, NY Times, October 28, 2022

The Hidden Danger Lurking Behind Musk’s Twitter Deal, Washington Post Opinions, October 28, 2022

The Robber Barons Had Nothing on Elon Musk, NY Times Guest Essay, October 27, 2022

Musk Tells Advertisers Twitter Will Not Be a “Free-for-all” Hellscape, CNN, October 27, 2022

Twitter’s Q2 Results Announcement, July 22, 2022