On Friday, Elon Musk's lawyers sent a letter to Twitter Inc. (NYSE:TWTR) informing the company that the billionaire was withdrawing from their acquisition agreement. It also filed the letter with the SEC.
Musk claims Twitter has not given him enough information about the fake accounts or "bots" on its platform, so he suspects the fake accounts are far more than the 5% or so claimed by the company. Therefore, he is entitled to withdraw from the deal. Musk's lawyer, Mike Ringler, claimed in the letter that for nearly two months, he has sought data to judge the prevalence of fake or spam accounts on the social media platform, but the company had not adequately provided the information.
Reputed to be the world's richest person, Musk, who controls companies like Tesla Inc. (NASDAQ:TSLA) and privately held SpaceX, began his campaign to acquire the social network company on or around April 4. At that time, he revealed he had acquired 9% of Twitter's stock and was seeking a board seat. After some back and forth with the company about joining the board of directors, he backed out and announced his intention to take over the entire company.
On April 25, Twitter announced it had reached an agreement to sell itself to Musk for $54.20 per share.
Musk filed documents detailing the committed financing put in place to fund the acquisition provided by a consortium of banks and composed of a senior secured bank facility, secured and unsecured bonds, a master loan facility (using Musk's Tesla stock as collateral) and an equity contribution.
However, soon after finalizing the deal, which appeared to have been done without much due diligence on Musk's part in early May, he said in a tweet that the "Twitter deal [is] temporarily on hold pending details supporting calculation that spam/fake accounts do indeed represent less than 5% of users." Musk's tweet referred to a Reuters dispatch from May 2 that cited Twitter's 10-Q filing, in which the company disclosed the issue of fake accounts and their responsibility for fewer than 5% of its monetizable daily active users. He added unreassuringly in a follow-up tweet that he was still committed to the deal.
Twitter stock promptly took a dive, settling to a discount of about a third from the deal price, showing considerable doubt that a deal would be consummated at the agreed upon price. It appears to me that Musk is experiencing acute buyer's remorse and, followed by the bear market, is using the fake account issue to renegotiate the price he had agreed to before.
The following chart lays out the price action for Twitter and Tesla (the electric vehicle company of which Musk controls about 17% of the stock). Tesla stock has fallen about 30% year to date, which is likely a major reason why he wants to get out of the deal as it has made a dent in his overall net worth as Tesla stock constitutes a large part of his net worth. According to news reports, Musk's net worth has fallen by $65 billion since he announced he wanted to buy Twitter.
Twitter vs. Musk: The First Shoe Drops
Twitter picks up the gauntlet
It looks like Twitter has picked up the gauntlet thrown down by Musk. The chair of Twitter's board of directors, Bret Taylor, tweeted on Friday that the board is "committed to closing the transaction on the price and terms agreed upon with Mr. Musk and plans to pursue legal action to enforce the merger agreement. We are confident we will prevail in the Delaware Court of Chancery."
While Twitter can push for a $1 billion fee Musk agreed to pay if the deal fell through, instead, it looks ready to force the closure of deal, which the company's board has approved and CEO Parag Agrawal has insisted he wants to consummate. Alternately, the court could award considerable damages to Twitter if it finds that it was Musk who reneged on the deal. The damages could be much larger than the $1 billion breakup fee and could include damages for the lost opportunity as well as the drop in stock price as a result of Musk's antics.
How and when will the second shoe drop?
There is quote attributed to 19th century German general and strategist, Carl Von Clausewitz, who said, We maintainthat war is simply a continuation of political intercourse, with the addition of other means."
We can say the same thing about litigation - it is a continuation of negotiations with the addition of other means.
Litigation involves a lot of public posturing, smoke and mirrors and bravado as the protagonists stake out their position. However, in the end, all the drama stops under the harsh light of the courtroom and skeptical gaze of a judge. The litigants are forced to reckon with the sword of Damocles hanging over their heads because, when it falls at the end of the trial, one of the litigants will be decapitated.
I expect Twitter will file suit in the Delaware Court of Chancery very quickly. Musk has been broadcasting his intention to renege on the deal since mid-May and Twitter is likely prepared to unleash its lawsuit. Since time is on Musk's side, I would expect Twitter to file a motion requesting an expedited trial, citing irreparable and escalating reputational harm arising from his unproven claim on misleading fake accounts as well as loss of talent and customers. If an expedited schedule is granted, expect the matter to be resolved quickly as both parties will be under the gun to fish or cut bait. On the face of it, Musk does not seem to have a good claim. Since he is reneging on the contract based on alleged misrepresentations by Twitter, the onus is on him to prove his allegation.
Currently, there is 32% spread between the deal price and Twitter's current stock price. This spread is likely to grow in the coming weeks as the litigants ratchet up the rhetoric and more details emerge. Assuming that a settlement is reached for a 20% discount on the deal price ($54.20 less 20% equals $43.36), Twitter is still trading at a roughly 18% additional discount. Thus, in my opinion, the arbitrage spread is excessive and tradable for Twitter longs because there is a high likelihood the fuss will be over in a few months.
Based on my observations, over 90% of all business litigation is settled. Both Musk and Twitter's board realize (or it will dawn of them, soon enough) that the longer this drags on, the more both of them will be damaged. So either Twitter will accept a cash payment from Musk (my guess is probably in the range of $2 billion) for Musk to walk away or agree to a price cut (my guess is a 10% to 20% discount) to get the deal done. If the case does end up in a trial, the judge will likely be tempted to let Musk off the hook by having him pay the $1 billion fee and costs to Twitter, rather than force a deal on a reluctant and unpredictable owner to the detriment of employees and the public. So I think it is in Twitter's interest to negotiate a reasonable conclusion and move on.
According to the GF Value chart, Twitter is significantly undervalued currently. The GF Value is slightly over $61.
Twitter vs. Musk: The First Shoe Drops
There is also an alterntive scenario that a white (or black) knight will emerge and offer to buy Twitter at a discount and then allow the company to continue pursuing Musk for damages. This scenario could put pressure on Musk to settle. I imagine discussions are occurring in the C-suites of these potential media and tech acquirers to strategize a gambit for this unique media property with tremedous unmonetized potential.
Overall, Mr. Market is offering an intriguing high risk, high reward merger arbitrage opportunity.
