Last week, we wrote that we thought the probability of Elon Musk completing his acquisition of Twitter (ticker: TWTR) for the agreed $54.20 per share price was remote, and argued that Twitter management’s unwillingness to provide backup for their claim that fake accounts were less than 5% was an indication that this was a real issue for the company. We’ve read analysis by attorneys who claim that even if fake accounts were 20% or 30% (a multiple of the claimed number), it still wouldn’t be “material” and that Musk should be forced to complete the deal as agreed. Those same attorneys also thought the probability of getting someone to pay $44 billion dollars who didn’t want to do so would be a bit of a stretch. Our view is that the number of fake accounts is indeed material, and that it’s hard to get someone to complete a deal who doesn’t want to do so.
A lot has happened in the last week, and it’s time for an update. Earlier this week, Musk got more serious about his threat to walk away from the deal. He went from tweeting and complaining in public to sending the company a letter indicating he was prepared to terminate based on this issue and filed that information with the SEC. Then, the State of Texas Attorney General announced an investigation into Twitter’s calculation of fake accounts. Yesterday, Twitter management announced they would provide Musk with full transparency on all tweets allowing him to do a full analysis of his own.
Our first thought is to wonder what made Twitter management change their mind on Musk’s due diligence request. While Musk waived his right to do due diligence as a condition of the deal, it’s been our contention that he’s asking a reasonable question on relevant information that Twitter has addressed in SEC filings. Whether he had a legal right to ask that question or not doesn’t change the fact that management’s weeks-long refusal to provide this information made them look like they were either lying about the 5% number or alternatively, wanted to kill the deal. We can think of four reasons management caved:
1) Musk went from tweeting about the issue to filing with the SEC that he had the right to walk away from the deal if he weren’t allowed to perform due diligence on this issue and that caused management to feel the need to respond.
2) The investigation (and ensuing lawsuit) by the TX Attorney General caused the company to reassess the practicality of the current strategy of denying the information request by Musk.
3) Twitter management realized that if they didn’t provide the information to Musk, they’d likely be sued for destroying shareholder value by scuttling the deal.
4) We’ve seen speculation that Twitter delayed in order to make changes that would falsely show Musk that the fake accounts were less than 5%. We note that we neither know how they’d go about falsifying the data nor have any proof of management malfeasance. With that said, we’ve previously pointed out that right after Twitter came to an agreement with Musk there was a substantial movement in number of followers for prominent accounts depending on their political allegiances so it seems likely that management has engaged in prior shenanigans.
So, what happens now? Here’s our best guess on the next set of events: First, whether accurate or not, we suspect that Musk’s due diligence won’t show evidence of fake accounts materially more than 5%. Perhaps his analysis will show a number a few percentage points higher which Twitter will reasonably claim isn’t material. At this point, Twitter management has Musk cornered. He’ll have the choice of completing the deal at the agreed $54.20 price, or to come up with a second reason to walk away. If he tries to walk away for a newly announced reason, it will be apparent that he just doesn’t want to buy Twitter at the original price. The merger agreement allows Twitter to go to court to force Musk to compete the deal if he terminates without proving some sort of material false claim by management. In this situation, Musk wouldn’t be able to pay the $1 billion termination fee; but rather, would have to buy Twitter at full price.
It would seem that under the most likely scenarios, the deal should get done, and with the stock trading at $40.40, that’s a 25% return in a couple of months. At a minimum, the probability of a full-price deal is higher now than it was a week ago. And yet, we still not certain this gets done. While Twitter can sue Musk to complete the purchase, management may decide not to pursue that long legal path. We don’t think Twitter management and most of its employees want to sell to Musk. We’ve previously opined:
Reasonable people can disagree about the range of acceptable public discourse, but what’s not up for debate is both sides have a divergent view for Twitter’s future. This is the most principled and least economic acquisition I’ve ever seen. It can be summed up as Twitter management being willing to sacrifice shareholder value for their preferred politics (which they sincerely believe to be the right and just course of action) versus the richest man in the world who is willing to overpay (in our opinion) for an asset in order to promote the value of free speech. This fight is 80% values and 20% economics.
On Musk’s side, there’s a lot of speculation that his interest in buying Twitter at $54.20 per share waned during the past few weeks as tech stocks have declined in price. While we think a second reason to not complete the deal is a bad strategy, Musk does have an alternative. The merger agreement provides Musk an acceptable reason to walk away if he can’t arrange financing for the purchase. Much of the debt financing is coming from longtime Tesla banker, Morgan Stanley. The firm has also advised Musk on his purchase of Twitter. If Musk doesn’t want to do the deal, he can call Morgan Stanley and tell them that if they ever want to earn future investment banking fees from Tesla, they need to find a reason to decline to provide financing. At that point, Morgan Stanley can claim that there have been changes in interest rates, in the debt markets, and in advertising pricing that provides Twitter with its revenue (or other business conditions) and say that they don’t think there’s still a market for the debt financing.
When contemplating the risk of a merger deal breaking, people often look at the pre-deal price for the company being acquired. In the case of Twitter, the stock is right around where it was when the deal was announced. However, only one month earlier, the stock was around $30/share and the tech market has declined since Musk began pursuing Twitter. With 25% upside if the deal is completed at the agreed price and around 25% downside if the deal breaks (based on current conditions), the market is telling you that it sees a 50/50 probability that the deal gets done – even though it now appears that all conditions to complete the deal will be in place.
We believe that what you’re seeing is the market recognizing the high probability that neither Twitter management nor Elon Musk actually want to complete the transaction. We warned you in the title that it’s a cynical analysis. For those of you who really want exposure to this bet, you might want to consider the August 19th $50 strike calls. With over two months to go until expiration, we’ll know a lot more about whether the deal will get done by then, and at the last price of $.70, you’d stand to make a 500% return if the $54.20 price holds. Please note that potential loss of capital here is 100% in the event that the transaction isn’t completed, gets done at a price under $50 on a renegotiation, or stretches into a months-long legal battle. If you take a position, size accordingly.
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