HomeAnalysisTwitter take-over bid: A case of leveraged buyouts

Twitter take-over bid: A case of leveraged buyouts

Tafara Mtutu
Twitter Inc has been trending on its own social media platform after the world’s richest person, Elon Musk, initiated a takeover bid for the company with a US$44 billion price tag on April 25, 2022, which equated to a 38% premium from its April 1 share price.

The billionaire’s reasons for taking over Twitter included a lack of confidence in current management as well as improvements to the platform like easing content restrictions and removing bots that spam and troll users.

The stock’s share price closed at US$51,70 on April 25, 2022, up 38% from January 31, 2022 when Musk began acquiring stock. Debt instruments totalling US$25,5 billion and equity worth US$21 billion have been lined up to fund the transaction, which will result in Twitter becoming a private company at its conclusion.

The takeover bid exhibits all the hallmarks of a leveraged buy-out (LBO). According to Bloomberg, the transaction, if concluded, will be the world’s fourth biggest take-private transaction ever done.

An LBO is the acquisition of a company using extensive debt funding. LBOs carry several advantages, chief of them being a lower cash outlay and in some cases, achieving tax efficiencies. In the case of Twitter’s takeover, we observe these advantages. According to the Bloomberg Billionaire Index, most of Musk’s wealth is tied to his Tesla shares, which account for roughly 84% of his total reported net wealth.

Footing the US$44 billion bill for Twitter with a sale of Tesla shares would likely jeopardise his controlling ownership of the EV manufacturer. In addition, such a sale would trigger jaw-dropping capital gains taxes given the appreciation of Tesla’s share price of 19 941,41% since its IPO in 2010. These taxes are avoided by taking out a loan and pledging Tesla shares as collateral. Given that the shares are held for strategic and not speculative reasons, the mechanics benefit all participants of the transaction (except the taxpayer, of course). Taking this a step further, if Musk improves the income generation-capacity of the platform, the profits earned can be used to pay off the loans used to take over the business, with little strain on Musk’s pocket and existing businesses.

A take-private LBO transaction also unlocks the long-term potential of the target entity. Listed businesses are often dogged by investor short-termism, which refers to the affinity of shareholders to realise value in the short term.

This phenomenon results in public companies undertaking short term projects that yield limited earnings compared to privately-run long-term projects that would require lock-up periods sometimes in excess of five years.

There are also disadvantages that accompany stakeholders in such a transaction. Existing Twitter shareholders will be exposed to reinvestment risk after selling their shares; the taxpayer’s earnings from the transactions are reduced by the tax efficiencies inherent in LBOs; and the highly leveraged position will expose Twitter to significant risk, especially when there is a market shock.

The success of LBOs has been mixed from an empirical standpoint. The RJR Nabisco LBO, which is arguably the most popular LBO in history, failed miserably after RJR Nabisco faltered under the heavy debt burden subsequent to the takeover. Manchester United Football Club’s current owner, the Glazer family, acquired the European soccer club through an LBO transaction.

The club was saddled with US$660 million in debt after the LBO in 2005, but good fortunes at the club have made this transaction one of the successful ones. Today, Manchester United Football Club boasts a market capitalisation of US$2,2bn.

There are currently no publicly documented LBO transactions that have been done among Zimbabwe’s listed equities, and we opine that this is because of a myriad of country-specific risks and very limited exit options. The operating environment in Zimbabwe has been volatile for some seven years now because of changes in currencies, weather-driven risks, and very tight capital mobility, among other factors. LBO strategies are often followed by an exit strategy by the acquiring company after realisation of returns. In Zimbabwe, exiting a private equity position is affected by the economic environment and limited to very few entities with the muscle to buy a large and successful business.

Exiting through listing the business on a public exchange is also marred by the currency of the bourse (Zimbabwean dollar) which has been the black sheep of currencies both locally and globally in recent years.

We also note that Zimbabwe’s financial services sector does not yet have the depth to structure instruments beyond traditional loans, nor are there secondary markets that repackage such debt instruments into special purpose vehicles like CDOs that can be used to lower banks’ exposures to mezzanine debt instruments.

  • As an epilogue to this article, the Twitter transaction has been put on hold pending details on fake accounts on the platform, and this subsequently weighed down Twitter’s share price from US$51,70 on April 25, 2022 to US$40,72 on May 13. It would certainly be interesting to monitor the progression of this transaction as the market gauges whether it will be a success story or another fad.
  • Mtutu is a research analyst at Morgan & Co. — tafara@morganzim.com or +263 774 795 854

 

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