Twitter Update
Merger Agreement Signed
This is a slightly revised version of a note sent this morning to my Corporate Financial Policy students, re Elon Musk’s bid for Twitter.
By now you will all have seen the news that Twitter's board agreed earlier this week to sell the Company to Elon Musk, in an all-cash deal at a price of $54.20 per share. The deal is scheduled to close sometime in 2022.
There has been a lot of news flow about the events that led to this outcome, as well as plenty of speculation about how Twitter’s business may change under Musk's ownership. I won't attempt to summarize all of this, but I will provide a bit of commentary about the deal itself and how the Twitter board came to accept (if not embrace) it:
-- The dynamics within the Twitter board reportedly changed dramatically once Musk announced that he had obtained "committed" financing, and dropped the financing condition from his initial offer. This is a classic case of corporate finance WTF, which in this context means "Where's the Financing?". The Twitter board was initially skeptical of Musk’s ability to fund the deal, but once Musk came up with the financing his credibility as a bidder went up dramatically and put pressure on the board to consider a sale.
-- The decision by Twitter's board to engage with Musk was also influenced by an intrinsic valuation analysis conducted by Twitter's bankers, JPM and Goldman Sachs, which reportedly concluded that in some operating scenarios the present economic value of Twitter's forecasted future cash flows could be below Musk's offer price of $54.20. Once the board determined that Twitter's stand-alone business plan might not generate economic value in excess of the cash being offered by Musk today, the decision to sell (at this price) became much easier to justify. This is a great example of DCF analysis in action, and how this form of financial analysis is used to make and influence important corporate governance decisions.
-- The board's decision to sell may also have been influenced by rapidly deteriorating conditions in the stock market and particularly in the tech sector. As the market value of high-growth tech stocks has continued to fall, selling out for cash at a high fixed price (not subject to market risk) will likely have looked more attractive to the Twitter board (and its shareholders).
-- Despite great publicity and the efforts of Twitter's bankers, it appears that no other credible competing bidders surfaced, making easier the decision to engage solely with Musk, even on his "take it or leave it" negotiation terms.
-- As a result of the deal, Twitter itself will be taking on $13bn of acquisition debt, with the proceeds used to fund the share acquisition and to refinance some amount of existing Twitter debt. It is not clear to me how much of the $13bn debt is actually incremental to Twitter, which at year-end had about $4.2bn of outstanding financial debt along with over $6bn of cash and short-term investments. According to at least some analyst estimates, Twitter's annual interest bill will go up from $50mm a year to over $800mm a year, equal to about 50% of annual operating profits (EBITDA?). I cannot verify these numbers, but in any event it seems clear that Musk is taking on a lot of financial risk as part of this deal, at a time when equity values are falling, interest rates are rising and the economic outlook looks increasingly uncertain.
-- In addition to the new debt taken on by Twitter, Elon Musk is taking on $12.5bn of personal debt which will be secured by $60bn of Tesla shares (at current market prices). This margin debt will cost Musk hundreds of millions of dollars of annual interest expense--$500mm a year at an interest rate of 4%--to be paid by him personally. It is unclear how he will source the cash needed to make these annual payments, but one option may be to sell more Tesla stock (and pay down the margin loan with interest). This possibility has not been lost on the shareholders of Tesla, the share price of which is down 20% since Musk first surfaced as a large Twitter shareholder.
-- Musk must still raise an additional $21bn of equity funding to complete the deal, which is no longer conditional on financing. He either needs to put up all of this money himself or find other investors to share the risk with him. If he cannot come up with the cash, the acquisition of Twitter will collapse and the lawsuits (and recriminations) will fly. Musk will also owe Twitter a $1bn break-up fee agreed as part of the deal.
— The major remaining condition to closing of this deal is the vote by Twitter’s shareholders to accept it. As I write, Twitter shares are trading below $49, a 10% discount from the announced deal price of $54.20, reflecting I suppose some risk that the deal may not in fact be completed.
-- There has been a lot of speculation about what Musk might (or might not) do operationally with Twitter, but given the high price paid and the large amount of financial leverage incurred, he will have to think twice about the impact of any such operational changes on Twitter's cash flow. Twitter currently generates about $5bn a year in revenue, 90% of which is from the sale of advertising, and Musk will likely be hesitant to risk losing this cash flow anytime soon. Musk may also want to take a look at Twitter's announced growth plans, and the expenses and capital investment required to support this growth. Musk has said that he can make Twitter much more valuable than it is today, but given the financial constraints he has taken on he will have to be very sensitive to the impact of any such moves not just on long-term value but on near-term cash flow as well.
In any event, the Musk-Twitter story is not yet over and so I encourage you all to follow the news flow, at both Twitter and Tesla.
Links:
How Elon Musk Won Twitter, WSJ, April 26, 2022
Musk’s Buyout will Load Twitter with Debt, WSJ, April 26, 2022
Twitter Press Release Announcing Musk Merger, April 25, 2022