I want to focus on the recent developments in Musk's offer to acquire twitter, and some aspects not always discussed in 3 minute finance articles or headlines. But first, a refresher:
Elon Musk built a 9.2% stake in Twitter during the first few months of 2022. On April 20th, he offered to take Twitter Private recently at $54.20 per share, claiming he can unlock the company’s potential. Musk secured financing the next day and entered an agreement to buy twitter. Recently he announced the deal was “on hold” pending investigation of spam and bot accounts.
This recent development about bots is unusual, especially considering Musk’s proximity to Twitter. This should have been a known concern to Musk. One would think he would have investigated this before he agreed to purchase the company. So, what exactly is going on? Why the erratic behavior? To understand, we must first look at Musk’s financing:
Musk Secured a total of $46.5B in funding on April 21st. This includes: $13B of debt for Twitter the company, 12.5B in margin loans secured against Tesla stock, and $21B in equity investment from Musk.
The debt and margin financing has a variable interest rate of 3-month SOFR +3%, and will currently cost $1B in maintenance per year plus 5% amortization for both debt facilities. Twitter cash from operations was only $600M in 2021, and not likely to exceed $1B in 2022..
The $12.5B margin loan has an initial 20% LTV with a margin call at 35%. This will require $62.5B of Tesla shares to be pledged. The fall in Tesla’s stock price has made this facility unattractive. As of close Friday, Tesla was worth $769.85 per share. This equates to a pledge of 81.2M shares at current prices. Musk had 88.3M shares pledged as of 6/30/2021, this would bring the total to 169.5M of 173M shares. This is likely not very palatable for Musk or Tesla investors.
The $21B in cash required to complete the deal throws in an extra wrench. If he were to sell Tesla shares, he would have to sell at least $25B, likely more, to come up with $21B after tax. He can’t do this and pledge sufficient shares for his margin loan facility. Spacex is highly illiquid and likely not useful as collateral. His final option is to find additional investors to come up with the $21B. This is unlikely to happen, investors are already unwilling to buy Twitter at a 30% discount to Musk’s acquisition price with Musk as the largest shareholder, and Musk's claim that he “doesn’t care about the economics” does him no favors in this endeavor. There were reports he asked around the big PE firms, none of which were interested in equity. The debt load added in the first financing transaction will also make twitter equity even less attractive to investors.
On May 13th, Musk took to Twitter to say his acquisition was on hold pending investigation of the calculations of bots and spam accounts on twitter. There are no carve-outs in the acquisition agreement to allow him to do this. Further, to expedite the deal, he waived any right to view additional non-public financial and analytical data from Twitter. Twitter already discloses that their mDAU spam estimate may not be accurate.
Per Twitter’s most recent 10k:
The numbers of mDAU presented in this Annual Report on Form 10-K are based on internal company data. While these numbers are based on what we believe to be reasonable estimates for the applicable period of measurement, there are inherent challenges in measuring usage and engagement across our large number of total accounts around the world. Furthermore, our metrics may be impacted by our information quality efforts, which are our overall efforts to reduce malicious activity on the service, inclusive of spam, malicious automation, and fake accounts. For example, there are a number of false or spam accounts in existence on our platform. We have performed an internal review of a sample of accounts and estimate that the average of false or spam accounts during the fourth quarter of 2021 represented fewer than 5% of our mDAU during the quarter. The false or spam accounts for a period represents the average of false or spam accounts in the samples during each monthly analysis period during the quarter. In making this determination, we applied significant judgment, so our estimation of false or spam accounts may not accurately represent the actual number of such accounts, and the actual number of false or spam accounts could be higher than we have estimated.
Twitter discloses that their calculation of spam mDAUs could be greater than 5%.
Recall Musk’s financing woes mentioned earlier. Contrary to popular belief, Musk cannot break the contract at his discretion and pay the termination fee. The only ways that Musk could leave are if twitter misled him or his financiers pulled out. The goal of Elon’s bot check appears to be to find Twitter in violation of reps and warranties. This would give him a $1B termination fee. If it could be shown that Twitter misled Musk (and investors) about the presence of bots, they would be in violation and Musk could terminate the contract. He can then reconsider entirely or offer a lower price for the acquisition, which he can more easily afford. Given the above stated information, I find it difficult to believe Twitter can be found in violation of reps and warranties. Musk specifically skipped DD that could have revealed flaws in their calculation methods and Twitter makes clear that, despite their best efforts, Twitter could be off in their assessment of bot or spam mDAUs.
On the 14th, Musk said his team would check 100 accounts following @twitter to see if more or less than 5 are bots. If asked for critique, any high school stats student could absolutely demolish this asinine experiment design.
Musk appears to be in a legal pickle. He has already agreed to buy Twitter, but the financing terms have turned against him. Obviously he still has sufficient assets to buy the company, just not on the terms he or Tesla shareholders would like.
I don’t see there being enough evidence to find twitter in violation, no matter how many bots are in the 100 sampled accounts following @twitter. This would mean that twitter would be able to compel Musk to complete the transaction, even if it is against his will. Unless he loses financing, which was almost entirely unconditional, he cannot escape. But, would they? Twitter’s existing board and management has little incentive to follow through. It would be a long, messy , and expensive legal battle that would ultimately result, if successful, their new boss sacking them vindictively.
This looks like a clear cut case of buyer’s remorse for Mr. Musk. His financing of the deal is likely already unattractive for Tesla shareholders and Musk himself, given the recent drop in Tesla stock. Virtually all social media companies have re-rated significantly lower since he made his offer as well. Musk either wants to pay less or leave entirely, it appears, and it will be very difficult for him to do this on paper. Musk has already violated many laws and norms so far, what happens next is anyone's guess. It will be interesting to see what comes of this.
TLDR: Deteriorating conditions and Tesla's recent fall has made the deal unpalatable for Musk. Musk must pledge 80M of his remaining 85M shares to his margin loan facility and come up with $21B to complete financing at Tesla's current price — something he can't do. He cannot simply break the contract as many people think. This bot search appears to be an attempt to find Twitter in violation, and likely should not work. If successful, he could leave or re-offer less.
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