At the peak of the buyout boom in 2007, private equity firms including Kohlberg Kravis Roberts bought Texas energy giant TXU for $45 billion. It was — and remains — the largest deal of its kind in American history.
Now a single billionaire is inching toward that record. Elon Musk, the world’s richest person, said this past week that he would pay roughly $44 billion to take Twitter private. If the deal closes, it would become the country’s second-largest buyout on record.
Musk is departing from the traditional private equity playbook by putting up far more of his own money than is usual in such a deal, about three-quarters of the price. But he is also following more standard practice for what Wall Street calls a leveraged buyout, borrowing $13 billion that would be transferred onto Twitter’s books.
In other words, his plan for Twitter includes both more cash than the typical buyout and more debt than Twitter may be able to handle, given its patchy profitability.
The structure of the deal means Musk’s push for unfettered “free speech” on Twitter could find itself in conflict with the company’s basic need to pay off its new debt. If less restrictive moderation of content on the platform leads to more unfiltered exchanges and misinformation, Twitter’s main source of revenue — advertising — could suffer, since most advertisers are wary of associating their brands with polarising content. And the company does not yet have other meaningful sources of revenue, although it has experimented with subscriptions. If advertising revenue falls, Twitter, which employs more than 7,000 people, could struggle to make interest payments.
The acquisition is also a big financial risk for Musk, more than usual for private equity-style buyers who often limit their exposure by using mostly borrowed money instead of cash. Because of the way the acquisition is structured, a downturn in Twitter’s fortunes could stretch even Musk’s considerable financial resources — and challenge his reputation for business savvy.
And because Musk is both selling Tesla shares and putting them up as collateral for personal loans to raise cash, Tesla’s value would be linked to Twitter’s. Any trouble at Twitter could force Musk to draw on his stock in the electric carmaker he runs to plug potential holes. And any problem at Tesla that caused its stock to fall far enough could trigger clauses in Musk’s personal loans that would require him to add more collateral, limiting his ability to invest in Twitter.
“I don’t care about the economics at all,” Musk said at a TED conference a day after making his buyout offer. The businessman, whose career is marked by upending industry norms, said that the deal is “not a way to make money.”
Musk has not explained what kind of owner he will be: a benevolent steward or a private equity-style overlord intent on cutting costs. Bloomberg News reported that Musk had pitched a business plan for Twitter that included layoffs.
Perhaps Musk is approaching this acquisition the way other billionaires have approached their media purchases: not to turn a profit, but to secure an entity’s future. But the size of Musk’s bet and the debt involved in financing it put the Twitter deal in a different league from, say, the $250 million purchase of The Washington Post in 2013 by Jeff Bezos, or Marc Benioff’s 2018 takeover of Time magazine for $190 million, both of which were fully paid for in cash.
Musk will ultimately be judged on whether he can make the numbers add up. Will his unusual financing plan secure Twitter’s future and prove critics wrong or seal its fate and squander a big chunk of his fortune?
Musk has offered $54.20 a share for the roughly 90% of Twitter he does not already own. To pay for this, he has lined up $46.5 billion. Of that amount, $21 billion is in cash, some of which comes from selling Tesla shares. This past week, Musk sold more than $8 billion in Tesla stock, according to securities filings.
Another $12.5 billion is from what is called a margin loan: money personally borrowed by Musk from a dozen banks with his Tesla shares pledged as collateral, carrying an interest rate of about 4%.
The remaining $13 billion is in the form of loans from a group of seven banks that will become Twitter’s responsibility to repay. The banks are charging relatively high interest rates on these loans, from about 5% to more than 10% in some cases.
Twitter’s earnings before interest, taxes, depreciation and amortization, or EBITDA — a key measure of its capacity to service its debt — is roughly $1 billion a year. The typical leveraged buyout puts debt worth six times a company’s EBITDA on its balance sheet, according to LCD, a data service. The debt in Musk’s proposal is twice as high.
“It’s rare for a company that is not generating as much cash, or is generating only moderate amounts of cash, to have this amount of debt, because you’ll starve the company of the ability to continue to hire engineers and seek out growth opportunities,” said Drew Pascarella, a senior lecturer of finance at Cornell University. But, he noted, “Elon would have the ability to fund the company with his own cash.”
Traditional private equity buyers use very little of their own cash. Instead, they borrow most of the money to pay for an acquisition. In the first quarter of this year, only 44% of the average value of all buyouts was paid in cash, according to LCD.
This structure is risky because a company can buckle under a heavy debt load. It is also potentially lucrative because the use of borrowed money — “leverage,” in industry terms — can increase the financial returns if the buyers eventually take the company public again or sell it to a new buyer at a higher price.
The greed and glory of private equity players was set out in gripping detail in the 1989 book “Barbarians at the Gate,” about the $25 billion leveraged buyout of RJR Nabisco by KKR and its subsequent fall. It cemented them in the popular imagination as among capitalism’s more rapacious actors, buying companies, piling debt on them, stripping costs, cutting benefits and laying off workers.
The takeover of TXU turned out to be a disaster, because a downturn in natural gas prices hammered its business as it groaned under the weight of its debts. Toys R Us went bankrupt in 2017 after the mountain of debt it took on when it went private in 2005 left it without the resources to compete against the rise of Amazon.
Musk first set out to raise debt financing for his bid by calling banks and other financial institutions starting the Saturday of Easter weekend. Bankers drew comfort, in part, from the fact that the deal would be backstopped by the world’s wealthiest man.
Still, the interest rates on the loans reflect the risk that they might not get paid back. The banks do not hold on to the loans but sell them to other investors in the market, so if Twitter cannot pay its debts, Musk will either have to pay those investors, perhaps by selling more Tesla stock, or he could cede some part of his ownership of Twitter, diluting his stake.
Tesla had a market value of $902 billion as of Friday, but its shares have fallen by nearly 20% since Musk first revealed, in early April, that he had bought a big stake in Twitter. If Twitter’s finances go south, forcing Musk to sell more Tesla stock to pay Twitter’s debts or pledge more shares as collateral for his personal loans, it could put further pressure on Tesla’s stock price. Musk does not take a salary from Tesla but is paid in stock that is released based on performance milestones that include the company’s share price.
Since Musk first disclosed his stake, the tech-heavy Nasdaq index has fallen more than 10%, making his offer appear even more generous. “It’s a high price and your shareholders will love it,” Musk said in a letter to Twitter’s board. Although the social media company’s stock had traded higher than Musk’s offer just six months ago, it slumped far below that price early this year and looked unlikely to return to those highs anytime soon.
Musk has considered teaming up with investment firms in his bid to buy Twitter, which would reduce the amount of money he would personally have to invest. He could still partner with a firm or other investors such as family offices to help raise cash, according to two people with knowledge of the discussions.
Thoma Bravo, a technology-focused buyout firm, has expressed willingness to provide some financing, but nothing has been decided yet. Apollo, an alternative asset manager, also looked at a possible deal where it would extend a loan on preferred terms.
If the deal math becomes unpalatable for Musk, he has an out: a breakup fee of $1 billion. For a man with an estimated fortune well over $200 billion, that is a small price to pay.
This article originally appeared in The New York Times.