The Dumbest Buyout

The Dumbest Buyout

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OK, look, it is April 20th – a date that  for some reason Elon Musk finds funny. 420   is a pot smoking reference, that in the real  world isn’t funny, but it’s really hilarious   if you are either a 15 year old boy, or a  tech billionaire. The only thing funnier   than 420 to people like this is the number 69. Look I dunno, I guess I’m telling you this,  

because I’m recording this video on April  20th, and it is about Elon Musk’s whimsical   attempt to buy Twitter. I guess I’m just trying  to warn you that this video could be really dumb.  Now, I probably should google 4:20 and tell you  guys a bit more about it, but I don’t really need   to do that as the comments section will be filled  with hundreds of comments starting with the word   “Actually…” And in truth I don’t really want  to know much about it, as I worry that if I   fill up my head with nonsense like this, that  there’s is a risk that it will push out some   actually useful information, and my channel will  eventually degrade into me discussing the genius   of using rocket technology to build tunnels –  which would most likely make the channel a lot   more popular. My overall goal with this is to  forget having made this video almost as soon   as it is uploaded, and I’ll probably do that by  listening to Razzlekhan music on repeat play until   I have forgotten pretty much everything, and then  I can get back to my longer-term goal of having   a channel that is mostly about rap and of  course rapping. [Really Good Rap Music Plays] 

The real struggle here is that trying to apply  financial norms to Musk’s proposed takeover   of Twitter is truly pointless and I guess before  digging into this story I’m trying to warn viewers   that if you don’t know about why he finds 420  funny and you don’t know about his possibly   jokey offer to buy Twitter for $54.20 per  share, maybe matching a different video is   a good idea. The world might make more sense to  you if you never hear about any of this stuff.  So, anyhow, you’ve been warned… Over the last few  weeks Elon Musk – the inventor of the lightbulb   and the tunnel – disclosed that he had bought a  major stake in Twitter, agreed to join its board,   reversed that decision and then launched a  bid to take the company private. His offer   values the company at $43.4bn, but he acknowledged  that his offer to take Twitter private may fail.  Now, Elon of course does occasionally like to  pretend that he will do mergers and acquisitions   because he’s bored, and he usually makes  such announcements on Twitter. He spent   around three weeks back in 2018 pretending  that he was going to take Tesla private at   $420 per share. Later claiming this was a joke  and settling fraud charges with the SEC. Of  

late he has started claiming that it was not a  joke… It is hard to know what to make of this.  Musk announced his bid to buy Twitter last  Thursday in a filing with the SEC in which   he said that he would “unlock” the company’s  potential to be “the platform for free speech   around the globe”. I think that what he means  by this is that once he owns Twitter he will   be able to achieve his childhood dream of  getting to call whoever he wants a Pedo.   And who are we to question the dreams of the  man who invented video games and twizzlers?  He announced on Twitter that he would  “endeavor to keep as many shareholders   in the new privatized Twitter as is allowed  by law”, insisting that he did not want to   “monopolise” or “maximise” his Twitter ownership.  So, I guess he wants to buy the whole company and   keep it owned by the shareholders – which  is a bit of a confusing idea. But anyhow… 

When Musk – the inventor of the battery and  the electric toothbrush - was pretending to   take Tesla private, back in 2018, he similarly  stated that he was going to let all of Tesla's   existing shareholders remain shareholders in  the new “private” Tesla. This of course made no   sense at the time and makes no sense today. It is  amazing that the man who invented the autonomous   vacuum cleaner and penicillin would put forth  a plan that makes so little sense like this.  In his typically understated fashion,  in an interview at a TED conference,   he described his bid as being a benefit to  humanity. “Civilizational risk is decreased   the more we can increase the trust of Twitter  as a public platform,” he said. So yeah…  Now, we must keep in mind that reducing  civilizational risk is of great importance   to Musk – the inventor of the space shuttle – as  if he saves civilization through his purchase of   a website, he might not need to move to Mars (as  he appears to be planning), where the average   temperature is around -80 degrees. Now, some  of you are possibly wondering if that is -80  

Celsius or Fahrenheit – and it doesn’t actually  matter – its minus 80 degrees, and there is no   coat that will help you out in that situation. If Musk can save civilization by owning a social   media company, he avoids living the rest of his  life in a freezing underground bunker on a distant   planet. So you can see why this matters to him. Now, he also announced that he doesn’t care about   the economics of the deal at all, adding that  he has a “plan B” if the bid is not successful.   The stock price fell 1.7% on the  day of his announcement to $45.08  

implying that the market puts lower odds  on Musk buying Twitter after his formal   announcement than it did before the announcement. I’m guessing his plan b is the underground bunker   on Mars, but feel free to let me know what you  think it might be in the comments section below.  So, is this even a serious offer? Well, Florida  Man - Governor Ron DeSantis seems to think that   it is. He is threatening to “go after” Twitter’s  board of directors saying that the firm fumbled   its fiduciary duty by trying to scuttle a sale  of the company’s stock at a premium. But company   boards are not obliged to just accept every bid  that comes in above the current share price,   or to even let the shareholders decide. The way  corporate law works is that if the board decides   in good faith that keeping the company independent  and executing managements existing business plan   will be worth more to shareholders in the  long run than Musk’s stoner themed offer,   then they are allowed to decline the  offer, with no breach of fiduciary duty. 

Musk’s $54.20 a share offer, is - as  he points out - at a premium to the   price the shares were trading at when he  started buying his stake a few months ago,   but it is well below the levels the stock traded  at quite recently — its stock traded above $54.20   on most days last year, so $54.20  may not be seen as a tempting offer   to many long term shareholders, and  many have come out and said that.  As we know, Elon Musk – the inventor  of Tiramisu and the hair transplant   uses Twitter polls to make almost all of  his important life decisions and so he of   course tweeted a poll, asking if “Taking Twitter  private at $54.20 should be up to shareholders,   or the board.” And the good people of Twitter  voted that it should be up to shareholders. 

Now there is (of course) a way of  letting shareholders make this decision,   a buyer could launch a tender offer,  which goes directly to the shareholders,   and doesn’t technically have to be approved by  the board (even though they usually are). If   the shareholders agree to sell their stock at  that price, the deal gets done. But this is not   what Elon Musk – the inventor of teenage angst and  roll-on deodorant did. He instead he sent a vague   nonbinding letter to the company with a purchase  price that is designed to make stoners laugh.  Now as I said, most tender offers do get  board approval first, and this is because   boards can usually block a hostile tender offer  by implementing a poison pill – which is just   what Twitter has done, and I’ll explain  how these things work in just a moment.  Now, a big question that  we are seeing in the press   is whether Musk can actually secure the financing  to do a deal like this or not? The price action in   the stock implies that market participants are  not really taking this deal seriously and that   they don’t believe he can close the deal. When  he was asked at the TED conference if he had  

“funding secured” he replied, “I have sufficient  assets.” And what that basically means is no.  He is not pretending to have financing in place  this time - his offer is contingent on “completion   of anticipated financing,” and due diligence.  What that means is that there are many ways he   could back out of the deal. If the market thought  the deal was likely to go through, the stock would   be trading much closer to the bid price. If the  market believed that another buyer might step in,   the stock would be trading above the bid price.  Right now, investors are not getting involved  

as it is just as likely that he dumps his  shares as that he tries to complete a deal.  A lot of people will say that Musk – the inventor  of underground taxis and underground traffic jams   is a wealthy man and he can simply finance  the purchase himself, after all he is worth   260 billion dollars on paper and he only  needs to come up with around $40 billion   to buy the rest of Twitter at $54.20 per share. The most straightforward way for him to do this   would be to sell some of his stake in Tesla and  SpaceX. The downside of doing this, of course,   would be the hefty tax bill generated by those  sales. He would need to sell more than 50 billion   dollars of Tesla stock to get 40 billion in cash  – as he would need additional funds to pay the   capital gains taxes. This would likely push down  the price of Tesla stock, both because of the  

large stock sale, but more so because it would  signal to the market that he had lost interest   in Tesla and was moving on to focus on Twitter. You could see it as being a bit like the   way he appeared to lose interest in  Grimes when the Tesla Bot showed up.  Now, another way to raise the money would be  to pledge his Tesla shares in return for a   multibillion dollar margin loan which he could  use to do the deal, but unfortunately he has   already pledged over half of his Tesla  shares for loans, and is capped by Tesla   as to how many shares he can pledge in total.  The reason for this limit, is to reduce the risk   for Tesla that a dip in the stock price would  trigger a margin call which would then cause a   big liquidation of Tesla stock. He could possibly  push Tesla to change this rule if he wanted to.  Another problem with using his stock to  collateralize a multibillion-dollar loan   is that most banks would be nervous about taking  Tesla shares as collateral due to the volatility   of the stock – which is actually more volatile  than bitcoin. It is also a very expensive stock   meaning that it could fall a lot, making it very  unattractive as collateral for a lender. When you  

add in Musk’s reputation as a loose cannon, it  is unlikely that he could do a deal this way.  Other things he could do though, is to get  backing from a buyout firm, but once again   it is not obvious that they would want to get  involved in a deal like this - where Musk has   already announced that he “doesn’t care about the  economics at all.” If Musk was running Twitter,   he would likely be making all of the decisions,  and not making them with a focus on maximizing   cash flow – which would matter to a buyout firm. The Wall Street Journal reported on Monday  

that Apollo Global was considering investing along  with Musk in a potential deal. However, Apollo is   apparently only considering providing debt or  preferred equity funding, rather than equity.  One more approach would be to use Twitters  debt capacity to get financing from banks,   but Twitter’s cash flow from operations  last year was about $632 million,   which is just not going to support anywhere  close to the debt required for a takeover.  OK, so that is financing… Now, we know that Twitter implemented a poison   pill a few days ago. So, what does that mean?  Well poison pills are a takeover defense strategy   whose technical name is a “shareholder rights  plan”, and it is an idea that was invented in the   1980s – but, not by Elon Musk. Poison pills are  pitched as a strategy to protect shareholders from  

corporate raiders. So you might ask, why would  shareholders want to be protected from someone who   wants to buy their shares from them at a premium? Well, there are all sorts of buyout strategies   that exist, that might not treat all shareholders  fairly. A corporate raider might for example buy   up more than half of the shares of a company in a  tender offer, swap out the board of directors for   some of their cronies - then propose a merger at  a much lower price, which gets approved by this   new board of directors, and the remaining share  holders are forced to transact at that unfavorable   price. This is known as a two-tier tender offer. Corporate raiders sometimes even threaten to do   things like this and shareholders then cave in  to their demands, accepting a low initial price   to avoid getting a much lower price if they stay  on as minority shareholders. To a certain extent,   Musk is already threatening Twitter shareholders  by saying that 54.20 is his highest offer price  

and that he might dump his 10% stake  if the deal does not go through.  We should note that a chunk of Musk’s  stock purchases were done illegally:   He was required by law to disclose his ownership  stake by March 24th, but didn’t disclose it until   April 4th, and then he claimed to be a passive  investor at that point. This delay allowed him to   buy an extra 13 million shares at a lower prices  than he would have paid had he announced on time,   saving him (and costing the shareholders  who sold) as much as $150 million.  Twitter can quite reasonably argue that the  poison pill that they have put in place protects   existing shareholders from being tricked by  this type of unlawful secret stock accumulation   that Musk has already been seen to engage in. Now, the way poison pills usually work is that   a rule is passed that if a buyer acquires more  than a certain percentage of the company’s stock,   then the company is able to dilute that buyers  ownership stake. They do this by allowing all   of the other shareholders of the company to  buy more shares either at a discount, or by   simply giving all of the shareholders – other  than the corporate raider more shares for free. 

So, if for example, anyone builds a stake of let’s  say 15% of the company stock, the company then   distributes one free share of stock for each  existing share, except to the person who went   above 15%. So, everyone else’s shares count gets  doubled, knocking the raiders stake down to 7.5%.   There is no limit on how often the  company can do this, meaning that   the raider is forced to negotiate with the board  of the company if they are planning a takeover.  Now, this (of course) sounds a bit strange,  and a bit unfair so obviously it was   controversial when first implemented,  and when something is controversial,   there is usually a lawsuit. The Delaware Supreme  Court approved this tactic, in a 1985 decision,   noting that the board’s reason for “the adoption  of the Rights Plan was in reaction to a perceived   threat in the marketplace of coercive two-tier  tender offers” It was decided that drastic   measures, like the poison pill, are justified in  such cases to block coercive takeover tactics.  In the case of Twitter, if Musk or anyone else  acquires more than 15% of Twitter's stock,   then every other Twitter shareholder will have  the right to pay $210 to acquire $420 worth of   Twitter stock at whatever the market price is at  the time. Do you see what they did there – it’s a  

pot smoker joke – because in defending against  Musk, it’s important to be as dumb as Musk…  You have to understand that there will have been  lawyers who had to sit there in a meeting and   listen to a snickering Twitter executive insisting  that the number 420 be forced into the deal…   The lawyer will have said, yeah yeah, I’ll  put that in – they can buy shares at a 50%   discount, and the twitter executive will have said  no no, you have to put in the number 420 – it is   the only way we will be taken seriously by idiots… I feel that lawyer’s pain.  Anyhow, if triggered, the poison pill will both  destroy the value of Musk’s stake and dilute his   votes. In the 1980’s a lot of companies put poison  pills in place whether someone was trying to buy   up the shares or not. Today, they’re generally  only used to protect against corporate raiders,   and they generally have short expiration  dates. They are not considered great   corporate governance. In March 2020 when the  stock market fell quite a lot at the start   of the Covid Pandemic, a lot of poison pills  were quickly put in place by companies who   worried that hedge funds would exploit the  market crash by taking big positions in   their stocks and attempt takeovers on the cheap. Twitters rights plan expires in one years’ time.  

I guess they could have had it expire in 420  days – they possibly missed a trick there.  So, as of right now, there is a bit of a  stalemate, between Twitter and Elon musk – the   founder of Paypal and Tesla. The Twitter  board has managed to get some breathing space   and can consider this bid and possibly try and  find additional bidders in the open market.  The poison will encourage Musk to negotiate  with the board and to demonstrate that he has   financing lined up – essentially he will  have to show that this whole thing is not   an elaborate April Fools day prank. Musk is left with two main options,   he can negotiate with the board and try to  strike a friendly deal, or he can pressure the   board into dropping the pill with a tender  offer and a proxy fight. Right now he is   hinting that he will take the second approach. A tender offer is a public, binding document  

filed with the SEC, which is available to all  shareholders, it discloses the buyers plans   and most importantly in this case their  financing. Shareholders, if they like the   deal can tender into this offer. Now, Musk  won’t be able to buy the shares right away,   as the tender offer would be contingent on getting  rid of the poison pill. But if enough shareholders   tendered into this offer, the board would likely  go along with them and get rid of the poison pill. 

If Musk negotiates a merger with the board, it  allows the board to insist on protections for   all of the shareholders. They can require  that shareholders be given a choice of cash or   stock in the new private company and that  there be enough funding in place so that if all   shareholders elected for cash, they would get it. The board can still of course just say no to Musk,   but that is unlikely as shareholders would  possibly be upset with them and the stock   price would likely fall, but it is still  within the range of possibilities and if they   did this a court would be unlikely to intervene. Anyhow, if you enjoyed this video, it is mostly   based on my Corporate Finance book, there is a  link to it in the description below. For more on   the topic of Mergers and Acquisitions and how they  work and how they can be traded, you should watch   my video on Merger Arbitrage next. See you soon bye.

2022-04-26 00:50

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