I have always been fascinated by the fact that at the end of an auction in Australia, passers-by spontaneously applaud the “winning” bidder. In reality, all that person has done is pay more than anyone else (usually with the help of bank debt) for an asset. It could be a wise move to buy the asset before its price rises, or it could lead to bankruptcy and a lifetime of ruin – either way, the stock itself hardly deserves applause.
The widespread adulation for the world’s richest man, Elon Musk, after Twitter’s board granted Musk the opportunity to present his offer to shareholders with their support, has the same effect.
Twitter yesterday agreed to allow Musk to “acquire” the company for more than anyone was willing to pay. (Musk hasn’t bought it yet, the deal is still subject to a lot of things like shareholder and regulatory approvals, but everyone expects them to be relatively straightforward. big risk is that Elon will simply change his mind, because well, it’s Elon). When Elon was able to “secure funding” for his $54.20 per share offer, the board had no choice but to accept. Why? Because no one else who isn’t a selfish billionaire was going to pay anything like that for the company (Twitter was trading at $47 per share just before the offering, but at $33 per share it a month ago).
And before you say, “Hey Schwab, Twitter was trading at $66 per share just six months ago,” that’s kind of like saying a bald guy was handsome when he still had hair (and yes, I know that). ‘Elon was bald and isn’t anymore, so that’s probably a bad analogy).
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Since last year, inflation has soared to 1970s levels and central bankers around the world are furiously raising interest rates. As a result, speculators’ view of the markets has changed dramatically. Since October, PayPal is down 70%, Netflix is down 69% and Meta (Facebook) is down 45%. That Musk is willing to pay just 18% less than Twitter’s recent levels represents a massive win for Twitter shareholders and a huge risk for Musk.
The whole thing feels very Barbarians at the door: the infamous battle for the tobacco and snack company, RJR Nabisco, which took place in 1988. This takeover contest was so noisy a few the wall street journal journalists were able to write a 700-page book about it. But let me sum up the whole debacle in one sentence: A debt-fueled bubble allows rich old white people to use lots of other people’s money to overpay for an asset, which ends badly.
Musk, like many very wealthy people, is asset rich but relatively cash poor. His wealth is largely tied to two companies: Tesla and SpaceX. SpaceX is a private company, so it’s very difficult (but not entirely impossible) for Elon to monetize this short-term asset. Tesla is publicly traded, so he can either sell shares of Telsa (which the market hates) or take out a margin loan on some of his existing stake to help find his deal (which the market kinda hates less). This is where a large portion ($12.5 billion) of the $21 billion “cash” component of Elon’s offer comes from. It’s technically money, but in reality it’s money directly funded by being collateralized by another asset rather than Twitter (where the rest of the $13 billion in debt originated).
The growth of margin loans is the perfect symbol of an era of bubbles. The notion of a margin loan is that the underlying asset can support an investor’s fixed debts (it’s like getting a home loan). This is generally uncontroversial when the collateral has strong cash flow and is reasonably valued (residential mortgages historically fit this bill, which is why most people use debt to fund them).
Tesla on the other hand does not really fit into the category. Without getting into a long discussion of Tesla’s valuation (and there are a lot of really good things about Tesla), based on its last quarter’s net profitability, the company is trading on a price-earnings multiple. of 67. Remember that Tesla shares have already fallen 28% since October 2021, and fell 12% overnight.
And while Tesla’s revenue continues to grow strongly and its product is the clear market leader, other automakers are finally catching up, from traditional automakers like BMW and Volkswagen to all-electric rivals like Polestar. In short, it’s certainly possible that Tesla’s stock price could drop 80%, and if that happened, all hell would break loose.
There is a not inconsiderable possibility that Tesla shares will collapse, which could cause Musk’s margin lenders to “call back” this debt, essentially forcing Musk to sell Tesla shares to repay the loan. This would lead to a death spiral in Tesla shares, which would then force Musk to sell his stake to repay lenders at a much lower valuation. Bearing in mind that his other major asset is an illiquid stake in SpaceX (which may then also have to be sold at a discount sale price).
Let’s also not forget that Twitter itself lost $272 million last year and $1.13 billion in 2021. It’s not Berkshire Hathaway.
There are many other potential serious issues (the eventual removal of Donald Trump, how Musk would deal with criticism from business partners, China, etc.) that will arise from Musk owning Twitter. It’s also possible that it will significantly improve what has been a largely moribund product of innovation for a decade and accelerate the logical move towards subscription.
But it is a strange acquisition on which to bet the biggest fortune in the world.