Elon Musk’s Twitter Deal Is Different Than Most LBOs, Here’s How

(Bloomberg) -- What’s the easiest way to buy something? With other people’s money. That’s the key to almost all of the LBOs, or leveraged buyouts, that have dominated mergers and acquisitions for a generation. But while Elon Musk’s $44 billion planned takeover of Twitter is an LBO, it differs from most in several important respects. When you’re the world’s richest man and one who professes to not care about the economics of the deal, buying can be easier -- and certainly faster -- if you’re willing to put up what to virtually anyone else would be an awful lot of money. Here’s a look at the complicated transaction pulled together by the Tesla Inc. chief executive, and how it differs from normal LBOs.

1. What’s a leveraged buyout?

LBOs are acquisitions where debt plays a crucial role. The basic idea is to buy a company through a combination of equity and new debt. But the key is that the acquirer, most commonly a private equity firm, doesn’t borrow the money -- the target company does. LBOs limit the downside for the buyer, because it is only wagering its equity investment: If things go wrong, the company goes bankrupt, not the buyer. LBOs also increase the buyer’s upside because they can acquire bigger companies than they otherwise would have been able to afford.

2. How much leverage is there in most LBOs?

Private equity firms typically try to put in as little equity as possible, to increase their potential return. But the limiting factor is usually how much debt the target company can service without debt payments dragging it down -- as has happened in quite a few high-profile LBO flameouts. The ratio of equity is typically around 45% to 50% of the deal, but can be higher or lower depending on the situation. The word “leveraged” refers to a special metric that compares the amount of debt to a company’s earnings, and that ratio is typically high in these transactions. The upper bound is roughly 6 times, but that can go higher depending on the deal.

3. How is what Musk doing different?

Musk is playing the role of the private equity firm in Twitter’s leveraged buyout. But he’s one of the few people with so much money that he can commit to funding much of the transaction himself. While many details have yet to be revealed, it appears that roughly 72% of the financing package will come directly from Musk or in the form of cash he’s borrowing by pledging Tesla shares, unless he finds private equity firms or other investors to join in as partners. When Musk’s current stake in Twitter is excluded, his proposed purchase would be the fourth-largest deal in which a public company was bought and taken private.

4. What is the deal?

Musk has arranged $46.5 billion of committed financing to clinch the deal, meaning a group of banks and Musk himself are now on the hook for providing the cash to Twitter shareholders if the transaction goes through. The package consists of:

• $13 billion of commitments from banks for loans to Twitter to support the deal
• $12.5 billion in loan commitments backed by Tesla stock pledged by Musk in what’s known as a margin loan
• $21 billion of equity commitments

5. How much debt would that add to Twitter’s balance sheet?

Only the first element in that breakdown would be new corporate debt, roughly $13 billion. Twitter’s credit rating is already below investment grade, so this new debt will come in the form of junk bonds or leveraged loans. It will be structured as a series of temporary loans from a group of seven banks. As is normal in LBOs, the intention is for the banks to then sell that risk in the form of longer-term debt to outside investors, but the banks are on the hook and would have to cough up the money if anything goes wrong. Based on the structure laid out in public filings, the commitments would likely be replaced by $6.5 billion of leveraged loans, $3 billion of secured junk bonds and $3 billion of unsecured junk bonds. The banks also provided $500 million of a special type of loan called a revolving credit facility that Twitter will be able to borrow from and pay back over the life of the loan. 

6. What debt does Twitter have now?

Twitter has already tapped the junk bond market and has two outstanding bonds for about $1.7 billion total, plus some convertible notes. While the specifics are unclear at this stage, Twitter is likely to pay off existing debt as part of the transaction. If the LBO happens, Twitter will have billions more of debt on its balance sheet. Calculating leverage can be fuzzy because it depends on how to define and project earnings, as well as how to view different types of debt. But one thing is for sure: Twitter’s leverage will increase drastically. CreditSights, a credit research firm, sees total leverage increasing to a ratio of 9 times a measure of earnings, up from 3.7 times currently, according to a report published on April 25. 

7. What other debt is involved?

The $12.5 billion margin loan backed by some of Musk’s Tesla shares. Notably this is a loan between Musk and a total of 12 banks - the seven that provided the other debt commitments, plus five more. Much of Musk’s wealth comes from his ownership of Tesla, so even though this portion of the deal is technically a loan, it’s really more like an equity contribution from Musk. But the collateral of that loan depends on where Tesla shares are trading. If Tesla’s stock price drops below about $740 before this deal closes, Musk might have some trouble finding enough collateral to take out the full margin loan, wrote Bloomberg Opinion columnist Matt Levine on April 26.

8. Where is the rest coming from?

The equity commitments are where Musk has essentially promised to come up with cash -- $21 billion worth. He’s worth more than $250 billion, according to the Bloomberg Billionaires Index, but most of that is not liquid. He could potentially sell assets, including Tesla shares, to raise cash. Or he could partner with others. Musk and his advisers have been vetting potential investors interested in backing this portion of the deal, Bloomberg reported. 

9. What does this deal mean for Twitter’s finances?

The increased debt load means it will have little margin for error going forward. Private equity firms typically load up a company with debt, slash costs, and try to boost revenues. Earnings have to grow rapidly so the company can afford its high interest payments and eventually pay back debt. Some analysts are projecting that the deal will leave Twitter highly indebted compared to its projected earnings, which could mean pain if the company can’t grow fast enough.

10. Will investors buy into this plan?

Musk has convinced Twitter’s board of directors to accept his offer to buy the company at $54.20 a share, and next has to get shareholders to say yes. But unless he wants to foot the whole $21 billion equity stake himself, he’ll have to convince private equity firms or other investors that he has a plan that will increase Twitter’s earnings enough to make it a profitable deal. The banks funding the $13 billion debt portion will eventually need to convince investors in credit markets that Twitter will be able to pay its new loans and bonds back. Both those tasks could be complicated by remarks Musk has made about caring more about Twitter as a free speech platform over profits. In an interview on April 14, he said his offer to buy Twitter was intended to create “an inclusive arena for free speech,” not as a way to make money. How persuasive he is could determine just how much of this purchase comes out of his own pocket.

The Reference Shelf

• The mystery of how Musk will cover the $21 billion in equity to buy Twitter.
• Bloomberg Opinion’s Matt Levine writes about the many steps to completing the Twitter deal.
• How Musk’s $44 billion buyout seals his bond with the American right.
• Musk told a TED event in Vancouver that he wants to retain as many shareholders as possible.
• A QuickTake on private equity and LBOs.

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