Elon Musk has made a deal to buy Twitter, but will his acquisition of the social media platform make him a boss or a bag holder?
A bag holder is the Wall Street term for a person who is stuck with an asset in its decline, usually with no hope for a turnaround and no one to step in to help keep it afloat. That’s the kind of asset Twitter is, regardless of the fact that Musk is willing to pay $44 billion for it.
“Elon didn’t so much win Twitter,” Vicki Bryan, a credit analyst and CEO of research firm Bond Angle, told Insider. “He may be the bag holder who gets the company no one else wanted to buy, and is much weaker than reported numbers and market pricing suggest.”
If Twitter is going to survive, it has to generate enough income to keep the lights on and pay down the mountain of debt this privatization effort will put on its balance sheet — up to $13 billion as the deal stands now, though some details of Musk’s financing are subject to change.
Whatever the case, by Bryan’s calculations, Twitter’s not even close to being able to service the kind of debt this deal will bring on. And if it can’t, the company could end up being the bottomless, money-sucking pit that brings down Musk’s entire business empire.
The devil is in the details
In his rush to acquire his favorite internet toy, Musk waived his right to review Twitter’s finances. Sure, he claimed to not care about the economics of the deal, but that may have been a critical mistake.
As it stands, Twitter does not exactly rake in money — it brought in just under $5.1 billion in revenue last year and posted a net loss of $221 million, in large part due to the settlement of a class-action lawsuit brought by some shareholders. But even that doesn’t tell the whole story.
“There’s a lot of
and maneuvering in the reported profits, unusual items, and massive tax adjustments,” Bryan told me. “You can’t gauge this company until you know those numbers.” In other words, you don’t really know what you’ve got until you look under the hood.
The most notable under-the-hood item, according to Bryan, is the roughly $630 million Twitter paid in stock compensation to employees last year. Instead of paying their workers bigger salaries upfront, tech companies like Twitter (and Musk’s Tesla) offer employees stock that they then can sell down the line. That can be good for employees who hope that the stock is more valuable when they’re able to sell, and it’s good for Twitter because the company doesn’t have to pay that money out in cash or count it as an expense. But once the company goes private that will change, and employees will need to be compensated in cash. Twitter’s debts will need to be paid in cash too.
In 2021, Twitter said it made about $682 million in earnings before taxes, earnings, depreciation and interest (EBITDA). One of the items in this adjusted EBITDA is stock compensation. If you remove that piece, the company made just $52 million. That’s not pretty, especially considering that the company told investors in February it expected to raise the amount it spent on stock-based compensation this year to between $900 million and $925 million. It also makes Twitter’s leverage picture look a lot worse.
Analysts cited by the Wall Street Journal estimate that Twitter’s annual interest payments would balloon from $52 million in 2021 to $845 million after the buyout. Bryan sees the picture getting even worse because she believes the market is underpricing Twitter’s risk. She estimates that Twitter’s annual debt payment could hit $1.3 billion in a “worst case” scenario.
None of this is news to Twitter. It has known for some time that it would be cash poor this year. Back in December Twitter raised debt in order to buy back $4 billion worth of stock. Moody’s, the credit rating agency, warned this move was “credit negative,” because Twitter would be cash starved for a few quarters. It didn’t downgrade Twitter’s credit rating — which is already in junk territory — because it reasoned Twitter was going through an investment period and would come out the other side a stronger company.
“Interest rates on these bonds should be in the neighborhood of 10% to 12%,” Bryan said, referring to their price after the Musk deal. But because of Moody’s’ mercy they traded around 5% in February. What Moody’s likely did not foresee was Elon Musk waltzing in and piling billions of dollars worth of debt on top of that.
But now Moody’s, and fellow rating agency S&P Global, are already warning that the buyout could cause the company’s rating to fall even further, which would make it harder — and costlier — to raise more money in the future.
Elon is risking it alone for a reason
It’s not just Twitter that’s staring down a big debt bill when this transaction closes — Musk himself is going to be on the hook for a whole lot of cash. Last week Musk filed a non-binding letter with regulators detailing how he had secured over $46.5 billion in funding to buy Twitter. Part of that is over $20 billion in cash Musk promises to pay out of his own pocket, presumably by selling a lot of Tesla stock. It also includes a $12.5 billion margin loan that uses $62.5 billion worth of his Tesla stock as collateral. One hedge fund source who spoke on the condition on anonymity to talk freely about the deal told me the terms for this loan were “ugly,” and that their fund regularly pays much less to secure debt financing than the richest man in the world may pay to secure Twitter.
There are so many reasons why Musk is going to have to pay through the nose to get this loan — aside from Twitter’s financial prospects — but the most important ones boil down to trust. After Musk’s infamous “funding secured” tweet disaster in 2018 — when he falsely claimed to have the financing to take Tesla private — he lacks credibility. On Wall Street he’s the boy who cried “deal,” a loose cannon trying to take over a flailing business for which he’s revealed few plans, and no overall turnaround strategy.
“Musk’s terms are commensurate with him being an over-levered clown,” the hedge fund source told me last week. (Okay. Tell me how you really feel.)
Matt Levine over at Bloomberg estimates that, all told, Musk would be personally on the hook for $1 billion a year in debt servicing costs (and that will go up as the
raises interest rates throughout the year). Even for the richest man in the world, servicing that kind of debt may require payment in kind — more margin loans to service the margin loan — my hedge fund source pointed out.
And this is where Musk’s Twitter deal threatens the rest of his empire. Not only is he tying up a lot of his
second half of 2022 to be less profitable than the first.in Twitter — he’s also putting his other businesses on the line. About one-third of his stake in Tesla will be put up as collateral for the margin loan. According to the funding letter, if Tesla stock drops 40% — below $400 a share, in this case — he will either have to put up more of his stock or the banks will start selling the stock they have until they get their money back. This is especially risky given that Tesla’s stock is already wildly volatile. It was down 30% from its highs at one point in March, and analysts are already projecting Tesla’s
Tesla investors understand that this Twitter deal is a threat. The company’s stock dropped over 12% on Tuesday, wiping out $126 billion of the company’s value and shaving Musk’s stake by $32 billion. Not exactly a vote of confidence.
To limit his risk, Musk needs what we on Wall Street call “a big swinging d—”: a hedge fund or private equity firm with enough cash to write a multi-billion check and come on as an equity partner, joining him arm-in-arm on this damn fool idealistic crusade. But Musk has made that difficult for himself. Beyond Wall Street’s longstanding trust issues, corporate raiders who pull maneuvers like Musk’s usually have clear plans for how they can maximize the value of the company they are trying to acquire. So far Musk’s main reason for buying the company boils down to “I am a power-user of this product and I want it to be better for me.” And the specific business ideas he has shared, like authenticating users and cutting down on advertisements, aren’t necessarily revenue drivers. After all, 90% of the company’s revenue comes from ads. The target of a takeover also typically has a lot of extra costs that can be cut, or is flush with cash to pay back debt — neither of which apply to Twitter.
Finally, Musk has turned his takeover into a political circus. By couching the purchase in the vague language of free speech, he’s invited clowns from capitals around the country — from Washington to Tallahassee — to show up and perform. Not exactly the kind of environment Wall Street’s brahmin want to jump in on.
Musk may be having fun but, trust me, the market sees no reason for joy. After his financing letter dropped Twitter’s stock — which should have shot up on the news — notched down half a percent. More than a day after the deal was officially announced, it still hasn’t reached Musk’s offer price of $54.20 a share.
There’s little room for error here, and Musk has a history of learning lessons the hard way. Back in early 2018 he spent billions turning Tesla’s Fremont factory into a fully automated “alien dreadnought,” a move automakers and other experts said would not work. And it didn’t. Expensive machines had to be scrapped and Tesla had to go on a hiring spree, only to cull 9% of its workforce in June of that year. It was a mistake that almost bankrupted the company, but luckily Tesla could raise cash selling stock in the public markets. Musk will not be able to do that with Twitter.
More ominously, as Bryan pointed out, none of Twitter’s big shareholders stepped up to help Musk buy the company. They’ve gone silent. Once Musk’s financing appeared the deal went off like lightning and all their concerns, defensive maneuvers, and their poison pill, were forgotten. When you sell someone a lemon, you don’t protest too much.
For now, Musk feels like he’s winning, but once the deal is done he will still have a company no one wants, drowning in debt it cannot pay back. Twitter barely excited investors as a public company, and Musk’s army of fans cannot give it a leg up in the private markets. Tesla is on the line again, and Elon Musk is totally alone, holding what looks like — at least for right now — a heavy bag.
Linette Lopez is a senior correspondent at Insider.