Business Markets Mergers & acquisitions

OPINION

Elon Musk has made an awful deal for

Twitter but he won’t be the only one to
suffer

Stephen Bartholomeusz
Senior business columnist

October 27, 2022 — 11.53am

Elon Musk has committed to finalise his $US44 billion ($68 billion) acquisition of Twitter on
Friday in the US. The bankers to the deal will be nervous but resigned to their fate.

After months of trying to wriggle off the hook he fashioned for himself in April, the “Chief
Twit,” as he now dubs himself, has pledged to sign off on the deal. That means the consortium
of banks providing the $US13 billion of debt funding, led by Morgan Stanley, will themselves be
locked in.
Elon Musk made an ill-advised deal for Twitter. GETTY IMAGES

With the US sharemarket having fallen more than 16 per cent and the more-relevant Nasdaq
market more than 24 per cent since Musk first publicly expressed interest in acquiring the
social media platform neither the equity providers – the biggest of which is Musk himself – nor
the banks providing a mix of leveraged loans ($US6.5 billion), secured bonds ($US3 billion) and
unsecured bonds ($US3 billion) will be under any illusion that this is a good deal.

Musk is massively overpaying for Twitter, arguably by at least $US15 billion and probably more.

If Musk follows through on his public comments that he will get rid of 75 per cent of Twitter’s
employees and turn the platform into “X, the everything app,” the bankers will feel even more
anxious about their exposures. Trying to turn the loss-making social media business into an
American WeChat would be a high-risk, “all or nothing,” strategy.

Already there are estimates that the moment the banks sign their end of the funding package
they will be sitting on $US500 million or more of losses. That’s because, since they committed
to the deal, conditions in debt markets have deteriorated dramatically.

The US Federal Reserve Board has raised its benchmark interest rate by three percentage points
already this year, with the market expecting another 75 basis point increase next month and at
least another 50 basis points in December.

The yield on 10-year US government bonds has risen from about 2.5 per cent when Musk’s
pursuit of Twitter started to 4 per cent and the spreads for corporate debt have blown out
dramatically. New issuers in the high-yield bond market this month have been forced to pay up
to 15 per cent to raise their funds.
The $US1.5 trillion leveraged loan market that has been a key source of funding for leveraged
deals like Musk’s and which has provided the core of the debt funding for private equity
transactions, including some Australian deals, has almost completely dried up.

Issues of leveraged loans in the September quarter fell to their lowest levels since the financial
crisis of 2008-09 and there has been a significant increase in the rate of defaults on those
loans. In August alone there were $US6 billion of defaults, the biggest number since the early
phase of the pandemic.

The major US banks have already started reporting material losses on their leveraged loan
exposures, with Citi, Wells Fargo, JP Morgan Chase and Bank of America, among others with
smaller exposures, disclosing September quarter losses totalling about $US1 billion during
their recent reporting season.

Financial giant Morgan Stanley is one of the banks facing heavy losses on their loans. AP

To date, there have been more than $US22 billion of leveraged loan defaults this year, or about
three times the level experienced in the same period of last year. In the past three months
there have been about $US12 billion of defaults.

There are forecasts from those close to the market that the value of the defaults could triple
within six months and more than quadruple within a year as the magnitude of the surge in
interest rates stymies the ability of leveraged companies to refinance but, of more immediate
significance for the Twitter deal than the rate of losses is the effective closure of a market the
big commercial banks have relied on to syndicate their riskier loans.

Morgan Stanley, Bank of America and Barclays are Musk’s key bank bankers, along with Societe
Generale (historically very active in providing leveraged finance for private equity deals in the
Australian market), BNP Paribas and Japan’s Mizuho and MUFG (Mitsubishi UFG Financial
Group).
It is conceivable, if they were prepared to take the $US500 million-plus “hair cut,” that they
could sell down their exposure to Twitter by on-selling the debt at a big discount to its face
value.

The alternative is for them to retain the exposure on their balance sheets through to maturity
(or default) and hold expensive capital against it.

Confronted with similar predicaments this year, other banks (and Bank of America) have
chosen to take their medicine and dump their debt.

Bankers who provided the $US15 billion of debt funding for the leveraged buyout of US
software group Citrix Systems on-sold some of their bonds and leveraged loans at big discounts
to their face value earlier this year. The sales, at an effective yield of about 10 per cent,
crystallised losses for the consortium of about $US600 million. The banks were forced to retain
about $US6.5 billion of the debt on their own balance sheets.

Tesla shares have crumbled since Musk began his Twitter chase, wiping billions off his net worth. AP

Another banking syndicate recently ditched plans to syndicate $US3.9 billion of the debt they
had committed to the purchase of Lumen Technologies by Apollo Global Management because
of the lack of interest from investors.

With interest rates still rising and economic conditions worsening– a US recession appears
increasingly likely – the environment for syndications, which was booming at the start of the
year before the Fed started hiking rates and before Russia invaded Ukraine, has deteriorated
since those deals flopped.

If the Twitter deal looks likely to be a bust for the lenders, spare a thought for Musk himself.
The equity component of the offer is about $US33.5 billion, of which about $US7 billion has
been lined up from third parties. Unless he can solicit some more third-party equity, the rest
has to be provided by Musk himself. He had a pre-existing stake worth about $US4 billion at the
bid price and has since sold more than $US15 billion of his Tesla shares to help fund the bid.

Given what’s happened in equity markets since the big price was set, that Twitter equity will be
worth something considerably less than $US33.5 billion the minute Musk completes the deal.

There are estimates that the moment the banks sign their end of
the funding package they will be sitting on $US500 million or
more of losses.That’s because, since they committed to the deal,
conditions in debt markets have deteriorated dramatically.

Musk’s own net worth has diminished by about a third from its peak, with Tesla’s share price
tumbling more than 40 per cent since his interest in acquiring Twitter emerged. It has lost
about $US500 billion of market capitalisation.

The Twitter bid may come to be seen as the high-water market for leveraged transactions in
the post-GFC era, or at least a punctuation point for a decade in which the ultra-low interest
rates and ultra-loose monetary policies pursued by the world’s major central banks encouraged
leveraged risk-taking while inflating assets values, particularly for technology companies.

That era has ended, with inevitably unpleasant consequences for some lenders, those they lent
to and those who provided the equity for overleveraged companies and transactions.

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Stephen Bartholomeusz is one of Australia’s most respected business journalists. He was most recently
co-founder and associate editor of the Business Spectator website and an associate editor and senior
columnist at The Australian. Connect via email.