There has been a lot of hue and cry about the prospects of the wealthiest person in the world owning the world’s ‘digital townsquare’ and thereby wielding significant power through influence of public opinion. Whilst the real power of Twitter as a platform of influence is debatable given the relatively small user base (compared to a Facebook, Instagram or TikTok), what not many seem to be talking about is the economics of the deal itself. Whilst Musk claims that the deal is not necessarily a money making venture for him as much as it is to uphold his free speech ‘absolutist’ ideals, this piece in The Post raises questions about the deal going through itself. Indeed, the author reckons Musk will likely walk away from the deal paying the billion dollar break up fee. And the author, Steven Pearlstein is not new to excesses in the financial markets, having won a Pulitzer for his coverage in the run up to the global financial crisis. Besides, exposing the flawed math behind the deal, Pearlstein likens the deal to AOL’s purchase of Time Warner at the peak of the dotcom bubble. Since publication of this article, there has been news that Musk has brought in new investors to back him, including Oracle’s Larry Ellison, Sequoia and Binance. Yet, the article is worth reading in the context of deal making on the back of elevated share prices as currency.
“…Musk may be the world’s “richest” person, at least on paper, $44 billion may be a stretch even for him.
So far, Musk has arranged with a consortium of nine banks, led by Morgan Stanley, to borrow $13 billion secured by the assets and cash flow of Twitter itself — a common financing technique in the buyout world. The same banks have also agreed to lend an additional $12.5 billion using some of Musk’s Tesla stock as collateral.
Musk has not said where he plans to find the $21 billion in equity, or risk capital, that he has promised to invest in the deal. He could sell some of his Tesla stock, as he did last week, generating $8.5 billion before taxes. Or he could take on some hedge funds or fellow billionaires as partners, who presumably would want some say in how the company is run. The balance he’ll have to borrow by pledging his Tesla stock as collateral.
There are several problems with this financing scenario.
According to Tesla’s regulatory filings, Musk had already pledged about half of his 173 million shares of Tesla stock to fund other ventures and activities. He has now pledged an additional 40 percent to secure the new loans to buy Twitter. That leaves only 10 percent of his Tesla shares available as collateral. Because Tesla’s policies allow major shareholders to borrow only 25 percent of the value of each share that is pledged, that would appear to limit further borrowing against his Tesla shares to less than $5 billion.
All that borrowing might work out just dandy as long as the value of the collateral — Tesla stock — remains at or near the $1,000 per share it was trading at when the deal was announced last week. Yet in the week since the announcement, it dropped 15 percent, to $870, at least in part out of fear that the stock could get caught up in Musk’s Twitter misadventure. Should it fall below $750, Musk could run afoul of Tesla’s own leverage ratio. And if it were to fall much below $600, the banks could demand that Musk pony up additional collateral, requiring him to quickly sell some of his shares.
Should Tesla stock fall below $400, the banks would probably demand immediate repayment, triggering a massive, forced sale of Tesla shares, depressing the share price even further and prompting other investors to bail out of the stock.
A further decline in TSLA shares is a real possibility, given the bubble in tech stocks over the past two years, with already highly priced shares doubling in value. With last week’s dramatic sell-off, the tech-heavy Nasdaq has fallen 24 percent from its all-time high late last year, as the Federal Reserve has moved to raise interest rates and withdraw the extraordinary monetary stimulus that has propped up the pandemic-challenged economy and inflated the price of financial assets. Adding to the downward pressure, tech giants like Netflix, Apple and Amazon have reported or warned of disappointing earnings and sales growth, further undermining the confidence of a new generation of investors who’ve convinced themselves that tech stocks have nowhere to go but up.
Even when judged against the tech sector, however, Tesla has been a frothy outlier. Since March of 2020, Tesla shares have soared from $85 to as high as $1,243 in October, briefly giving the upstart carmaker a market value of more than $1 trillion — more than Toyota, Volkswagen, Daimler, Ford and GM combined.
Even today, with its shares down to below $900, Tesla is selling at a price 118 times its profit from the previous year. By comparison, Google’s parent, Alphabet, boasts a price-earnings ratio of 21, with Amazon at 38. By that or any other measure, Tesla remains overvalued.
Tesla is only now beginning to feel the impact of big-league competition in the fast-growing market for electric cars, in which it boasts a technological head start as well as a good deal of cachet among environmentally conscious consumers. Those advantages brought Tesla rapid sales growth for the past two years, once its early production problems were ironed out, and allowed the company to charge premium prices that last quarter generated a copious operating profit margin of 37 percent.
Even with that impressive record, the only way today’s sky-high valuation for Tesla makes sense is if you think those profit margins and sales growth will continue into the future. But with Volkswagen, Ford and other competitors rushing to bring out their own lines of electric vehicles, that seems unlikely.”
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