As I read them, the most recent SEC filings for Twitter say the company has been generating about $5 billion in yearly revenue, over 90% of which comes from advertisers. This generates about $1.5 billion in operating income.
Earlier this year, Elon Musk bought the company for $44 billion, or close to 30x current operating income. At first blush, and maybe for much longer than that, this seems to be a very iffy financial move, since it implies the expectation of red hot profits growth rather than the more pedestrian pace Twitter has set in most years.
To finance the purchase, Musk sold a chunk of his TSLA stock and tapped friends willing to chip in a few billion, raising about $30 billion thereby. He asked the big commercial/investment banks for the final $13 billion he needed to pay shareholders of Twitter, through loans they would make to Twitter would make the instant he took control.
Press reports indicate the banks balked at first and offered Musk a margin loan instead, meaning borrowings secured by something like (my guess) $25 billion of his TSLA shares, about a third of what he owns.
The risks for Musk in this arrangement are obvious:
—he personally, not Twitter, would be responsible for repaying the loan, and for the interest expense;
–a margin call (that is, a demand for more collateral) triggered by a fall in the TSLA share price could develop into a really ugly situation–in the worst case, the banks could sell off the TSLA stock into the weakness and close out the loan;
–professional short-sellers might find this margin arrangement a tempting target to exploit by trying to trigger a chain reaction of margin calls by aggressively shorting TSLA;
–you might even imagine circumstances where GM or F would scoop up TSLA shares as they were being pummeled, and end up larger holders than Musk–and maybe even in control of TSLA.
I wonder if Musk took this “offer” as a personal insult or simply a ploy to make a subsequent offer look better than it was.
In any event, the banks ultimately made a firm commitment to a series of loans to Musk-owned Twitter totaling about $13 billion, with annual interest payments capped at something like $1.5 billion. Put a different way, interest on these loans would suck up all of Twitter’s operating income. And that’s assuming Musk wouldn’t give free rein to hate speech by white supremacists or anti-Semites, thereby driving away advertisers. Knowing that this last was what Musk seemed to be intending, it’s not hard to imagine a sharp drop in Twitter’s operating income that would leave it unable to make required interest payments. Hence, I think, the idea of a margin loan, with much more severe consequences for Musk, instead.
The banks, nevertheless, ended up committing to provide the $13 billion in loans. They apparently did not plan to keep the loans on their books, but instead to sell them on to (gullible, in my view) fixed-income portfolio/hedge fund managers, collecting fees for acting as a middleman.
Two things happened that threw a monkey wrench into the banks’ plans.
–for some strange reason, Musk quickly signed an ironclad contract to acquire Twitter for $44 billion basically “as is,” meaning Musk waived his right to do any checking into the accuracy of Twitter’s financials, its public statements, the quality of its products, its assets or how business was going–or anything else, for that matter, and
–Musk subsequently spent a considerable amount of time, without success, trying to wriggle out from the contract Twitter had artfully prepared and he had signed. During this time, interest rates rose considerably, making the interest payment cap look unattractive, even to yield-hungry bond fund managers.
The result is that in a world where fixed income investors will seemingly buy almost anything, the banks have been unable to find anyone willing to take the Twitter debt off their hands at a price they would accept.
Twitter had just over $6 billion in cash at 6/30/22. Offsetting that, the change of control triggered the redemption of $3.6 billion in convertible debt and an offer to redeem $1.7 billion in straight debt. The company also had to settle outstanding employee stock and stock option grants. Let’s say that the net result was that the new Twitter started out with more or less no cash.
During the first half of 2022, R&D plus sales, general and admin expenses totaled $1.8 billion. Let’s assume that’s all salary, of which about a quarter ($459 million) was paid in stock. On a cash in – cash out basis, Twitter made about $1.2 billion in the first half. Were the company to pay employees completely with cash rather than including stock, its cash generation would have been about $740 million. Full-year cash generation would be just under $1.5 billion, all of which would presumably go toward interest payments on the bank debt.
A situation like this, where interest expense is devouring all the money operations are generating, is perilous. The best solution would be to grow revenue. But this takes time, and the Musk strategy of giving free rein to ate speech isn’t one that will necessarily draw more advertising …or more users. The alternative is to cut expenses. In this case, the latter means personnel expense. And the situation may be made more difficult if employees are unwilling to be paid through stock grants and want cash instead.
Musk seems to me to have clearly taken the cost-cutting path in a major way. Over the past couple of days, discussion of a possible bank margin loan has popped up again. This may simply be idle speculation. Were there any truth to the rumor, it would suggest Musk is having more difficulty generating revenue at Twitter than is generally undeerstood.