I’ve always been fascinated why, at the end of a house auction in Australia, bystanders 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. This could be a wise decision to purchase the asset before it increases in price, or it could result in bankruptcy and a life of ruin — either way, the action itself is hardly deserving of applause.
The widespread adulation towards the world’s richest man, Elon Musk, after the Twitter board awarded Musk the ability to take his offer to shareholders with their support feels the same way.
Twitter agreed yesterday to allow Musk to ‘acquire’ the business for more than anyone was else willing to pay. (Musk hasn’t bought it yet, the deal is still subject to lots of stuff, like shareholder and regulatory approval, but everyone expects them to be relatively straightforward. The bigger risk is Elon simply changing his mind, because well, he’s Elon). When Elon was able to ‘secure funding’ for his $54.20 per share bid, the board was left with little other option but to accept. Why? Because no one else who’s not an egotistical billionaire was going to pay anything like that for the business (Twitter was trading at $47 per share just before the bid but $33 per share a month ago).
And before you say, “Hey Schwab, Twitter was trading at $66 per share only six months ago”, that’s a bit like saying a bald guy was good looking when he still had hair (and yes, I know Elon used to be bald and no longer is, so that’s arguably a bad analogy).
Since last year, inflation has skyrocketed to 1970s levels and central bankers around the world are furiously hiking interest rates. As a result, speculators’ views of markets have changed significantly. Since October, PayPal has slumped by 70%, Netflix is down 69% and Meta (Facebook) has dropped by 45%. That Musk is willing to pay only 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 Gate: the infamous battle for tobacco and snack food company, RJR Nabisco that happened in 1988. That takeover contest was so raucous a couple of Wall Street Journal reporters were able to write a 700-page book about it. But let me summarise the entire debacle in a sentence: debt-fuelled bubble lets rich old white dudes use lots of other people’s money to overpay for an asset, ends badly.
Musk, like many very rich people, is asset rich but relatively cash poor. His wealth is largely tied up in two businesses: Tesla and SpaceX. SpaceX is a private company so it’s very hard (albeit not totally impossible) for Elon to monetise that asset in the near term. Tesla is publicly traded, so he can either sell shares in Telsa (which the market hates) or take a margin-loan on some of his existing stake to help find his bid (which the market hates a little bit less). This is where a big chunk (US$12.5 billion) of the US$21 billion ‘cash’ component of Elon’s offer comes from. It’s technically cash but in reality, it’s cash funded directly by being secured against another asset rather than Twitter (which is where the rest of the $13 billion in debt comes from).
The growth of margin loans are the perfect symbol of a bubble epoque. The notion of a margin loan is that the underlying asset can support fixed debt obligations of an investor (it’s like how you get a home mortgage). This is mostly uncontroversial where the collateral has strong cash flows and is reasonably valued (home mortgages historically fit this bill, which is why most people use debt to fund them).
Tesla by contrast does not really fit in the category. Without getting into a lengthy discussion of Tesla’s valuation (and there’s a lot of really good things about Tesla), based on its last quarter’s net profitability, the company is trading on price-earnings multiple of 67. Don’t forget, Tesla shares have already fallen by 28% since October 2021, and dropped 12% overnight.
And while Tesla’s revenues continue to grow strongly and its product is clearly market leading, other car companies are finally catching up, from the legacy automakers like BMW and Volkswagen to fully-electric competitors like Polestar. In short, it’s certainly within the realms of possibility that Tesla’s share price could drop 80%, and if that happened, all hell would break loose.
There’s a non-remote chance of Tesla shares slumping, which could lead to Musk’s margin lenders ‘calling in’ that debt, essentially forcing Musk to sell Tesla shares to repay the loan. That would lead to a death spiral in Tesla shares, which then causes Musk to have to sell his stake to repay lenders at a far lower valuation. Bearing in mind, his other major asset is an illiquid stake in SpaceX (which may then need to also be sold at a fire sale price).
Let’s also not forget, Twitter itself lost US$272 million last year and US$1.13 billion in 2021. Berkshire Hathaway it ain’t.
There’s lots of other potential serious issues (the possible unbanning of Donald Trump, how Musk would treat criticism of his business partners, China etc) which will flow from Musk owning Twitter. It’s also possible he may dramatically improve what has been a product largely moribund of innovation for a decade and accelerate the logical move towards subscription.
But this is a strange acquisition to gamble the world’s biggest fortune on.
Adam is the co-founder of The Lux Group and author of Pigs at the Trough: Lessons from Australia’s decade of corporate greed. He is also a member of the SmartCompany Brains Trust, a former Private Media board member and former corporate lawyer.
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