‘Elevated risk this deal doesn’t go through’: Why investors are beginning to doubt Musk’s blockbuster bid for Twitter

“It’s all anyone’s talking about,” one investment advisor at a London-based investment bank said of Elon Musk’s $44 billion bid for Twitter. Investor clients, analysts, investment bankers…they’re all watching with fascination the ups and downs of the Twitter share price—and that of Tesla—he told Fortune. And they’re all seeing the same thing: The markets are giving the deal, as it’s currently constructed, ever-worsening odds.

Start with Twitter’s share price. It closed on Thursday at $49.11—up 1.1% for the session, but badly underperforming the tech-laden Nasdaq, which rose 3.1%. After yesterday’s close, Twitter trades 9.4% below Musk’s offer price of $54.20. In fact, investors have been dumping Twitter shares since the social media giant approved Musk’s all-cash bid on Monday; TWTR is down 5.8% since Monday, and is trading lower in pre-market on Friday.

That weakness even follows big news overnight that Musk sold a further $4 billion in Tesla shares, a further sign, as if skeptical investors needed it, that the billionaire remains truly committed to buying up Twitter.

That so many gun-shy investors are unwilling to take up Musk on his offer so far speaks volumes. Here’s one way to look at it: If it goes through, Musk’s $54.20-per-share offer guarantees a nearly 10% upside return for Twitter shareholders (as of this morning). With tech stocks mired in a bear market; the Federal Reserve tightening, tightening, tightening; and Nasdaq bellwethers giving lousy full-year guidance, where else are tech bulls going to find a premium like that?

The takeaway: Some Twitter investors are at least gaming out the odds that Musk walks away from the deal.

“It’s not uncommon for a company’s stock to fall after agreeing to a sale,” says Robert Schein, chief investment officer, Blanke Schein Wealth Management, a wealth management firm based in Palm Desert, Calif. “There is always risk that a transaction fails to come to fruition.”

“There is elevated risk that this deal doesn’t go through,” he continues, “because it’s so high-profile and so widely scrutinized.”

As another investor told Fortune, “Nothing is drama-free in the world of Elon Musk.”

Puny breakup fee

Merger arbitrage is one explanation for why shares of the target company of an acquisition fall in the early days. Canny investors may see an opportunity to make a quick profit by selling out after the initial bump in share price when a deal is first announced. Later on, if the deal looks certain to be consummated, they may buy back in should the share price of the target company remain below the acquirer’s offer price.

Tim Pagliara, chief investment officer, CapWealth, a Franklin, Tenn.–based wealth management firm, reckons that “run-of-the-mill merger arbitrage” activity explains at least some of the poor performance we’re seeing in TWTR in recent days.

If there is a red flag, he says, it’s in the $1 billion breakup fee built into the deal, which “is at the low end for a transaction of this size.”

“If the breakup fee was $5 billion,” he continues, “Twitter’s stock price would likely be higher. The breakup fee itself says something about the likelihood of the deal getting done.”

Pagliara sees the puny divorce levy as a sign “there’s not a high level of confidence that a deal will be able to pass the various hurdles ahead, including regulatory approval and Musk’s further due diligence of Twitter.”

Other markets watchers have zeroed in on the billion-dollar-breakup, too.

Shorts at the gate

Another problem for Musk is his old nemesis, the shorts. They’re back.

As of yesterday, short positions as a percentage of Twitter’s overall float stood at 5.52%, says S3 Partners, a firm that analyzes such trades. That’s not an alarming number, but what pops out is the recent surge in short bets against Twitter.

The number of TWTR shorts has doubled since the start of the year, and has really picked up in the past two weeks. According to S3 Partners, investors shorted more than 7.4 million Twitter shares over the previous 14 days, amounting to a monster $361.4 million bet that the Twitter share price will go down, down, down.

The number of short sellers circling around Twitter will be something to watch in the coming weeks, markets observers say.

“If short positions were to exceed 10% of the float, that would likely act as a more meaningful signal about the market’s lack of confidence in the deal coming to fruition,” Schein says.

The Tesla factor

One of the peculiarities of this deal is that it involves Musk, and not a rival company, buying Twitter. A traditional M&A deal—think Company A buying Company B—often sees Company A’s share price take a hit, particularly if shareholders question how exactly Company A will finance its buying spree.

In the case of Twitter, the acquirer, Musk, has to liquidate part of his huge Tesla holdings to pay for the deal (the rest will come from a consortium of banks). And so, naturally, investors in the EV maker are now grumbling that they’re unwittingly being pulled into the deal too. Tesla’s shares have fallen 20% since it was revealed Musk had become Twitter’s largest shareholder—12.7% this week alone—so their gripes are at least somewhat justified.

If you’re looking for another canary in the coal mine for this deal, look no further than TSLA.

“Another factor to watch includes the value of Tesla shares,” Schein says, “which Musk is using as leverage to acquire Twitter. Should Tesla’s shares continue to drop, that may indicate that the funds may not be sufficient for the acquisition to proceed, though I still believe this is a long way from happening.”

So far this morning, Tesla shares are holding up in pre-market, perhaps buoyed by Musk’s comment on—where else?—Twitter: “No further Tesla sales planned after today.”