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Elon Musk’s latest move is part of a chess game—and the Twitter board may have made a key error

May 13, 2022, 11:00 PM UTC

It was the tweet heard round the world. In the early morning of May 13, Elon Musk posted “Twitter deal temporarily on hold pending details supporting calculation that spam/fake accounts do indeed represent less than 5% of users.” Within minutes, Twitter’s shares tanked from from $45 in pre-market trading––already a big discount from Musk’s takeover bid of $54.20––to well below $40, as investors fled fearing the most publicized and controversial acquisition gambit in recent memory was dead. Two hours after issuing the shocker, Musk tweeted “Still committed to the transaction.” The Wall Street shorts, longs and risk arbitrageurs handicapping this careening saga reversed course—and raised the odds it will actually happen—by sending Twitter’s price to $42 by mid-afternoon, well above the $39 mark before Musk first appeared.

Most likely, Musk’s May 13 moves are part of a chess game where the master’s maneuvering to either pay far less for Twitter than his original $46.5 billion offer, or walk away if its directors don’t cave. The chessboard has greatly shifted since Musk made his bid on April 5. By the time of his bombshell tweet, Tesla’s shares had tanked 28%, shedding $300 billion in value over just five weeks. Musk clearly harbored fewer resources to secure an incredibly costly, high-risk deal, especially since he intended to margin his Tesla’s stock to raise the needed cash, adding to the tens of billion in shares and options already pledged. Meanwhile, Twitter reported poor Q1 results, and the Nasdaq 100 dropped by over one-fifth from from the start of April through May 12. It’s virtually certain that Twitter’s stock would have fallen at least as much as the overall market were it not supported by Musk’s offer, possibly to the low-$30s.

The Twitter board left a huge opening for Musk to exit or recut the deal

Given the change in circumstances, it makes sense that Musk would recognize that he would be way overpaying at $54.20, and seek a much lower number. But it’s standard practice in takeovers for the target to impose ironclad restrictions that leave purchasers extremely limited, or even no scope to renegotiate. “Musk isn’t just waking up and thinking, ‘Wow, I’m paying much too much for Twitter.’ He’s proving himself a clever dealmaker,” says James Woolery, founding partner in law firm Woolery & Co. who’s worked on such high-profile deals as Clorox’s defense versus Carl Icahn, Dell’s campaign to go private, and Medco health’s merger with Express Scripts, and has a long history handling hostile transactions. “He’s a sophisticated player who wants to buy it on his own terms or not buy it. The Twitter board handed him incredible leverage that I’ve never seen in any other deal. Instead of being potentially liable for the entire $40 billion-plus purchase price, the board effectively gave him an $1 billion ‘option’ to buy Twitter. He should be facing liability of between $1 billion and over $40 billion.” Instead, marvels Woolery, the most Musk risks by exiting is a $1 billion breakup fee, while by threatening to depart, he could shave many billions from his offer––a deal the Twitter board would be hard-pressed to reject. (Twitter did not immediately respond to a request for comment.)

As Woolery explains, a breakup fee is payable in two classic situations. First, if anti-trust or regulatory authorities nix the acquisition. Second, if the target gets a higher or “topping bid.” The $1 billion penalty in the Twitter deal would apply in either of those cases, both highly unlikely. But the target’s board normally demands safeguards that make the purchaser legally liable for the entire purchase price if they simply withdraw because conditions change, in other words “buyer’s remorse”––the only exception being super-narrow Material Adverse Change clauses that would encompass a war, say, or an explosion that destroys a key manufacturing site. “The Delaware courts tend to side with the seller in these cases,” says Woolery. “They don’t like it when the buyer reneges.” He adds that in what started as hostile takeovers, those protections are at their tightest and most essential. “In a hostile especially, the board should ensure that the buyer has no way out,” he says.

In some instances such as the LVMH-Tiffany transaction, says Woolery, the purchaser leaves and risks a suit for the full purchase price. But the potential damages are so huge that the buyer usually settles for a price around 10% below their original bid. “The target would have to mount a lawsuit to force the buyer to close,” says Woolery. “They’re losing a lot of key employees already as if the new owner were already in charge. So they’re willing to settle for a lower price, but not a huge discount.”

Amazingly, the Twitter board effectively dumped such standard protections, and capped Musk’s potential damages at the $1 billion breakup fee. In other words, he can escape by paying Twitter $1 billion, around 2% of the agreed-upon price. Technically, Twitter can sue for the full price under what’s called “specific performance.” But if Musk simply “breaches” the transaction by refusing to close, the maximum he’ll have to pay Twitter is that $1 billion, equivalent to the breakup fee. Similar terms are typical in LBOs, but not in regular corporate takeovers. “The number one thing when you sign an agreement in public M&A deal is that the power shifts to the buyer. That’s why it’s so essential for the seller to get terms that makes it as difficult as possible for the buyer to get out,” declares Woolery.

The pivotal language comes in page 65 of the merger agreement, filed on April 25: “The Termination Fee shall constitute the sole and exclusive monetary remedy of the Parent [Musk] as a result of the failure of the transaction to be consummated.”

“The dynamic on this deal is beyond belief,” marvels Woolery. “The Twitter board did the deal virtually overnight. It looks rushed, as if they were so happy to get the offer they didn’t demand the right protections.”

Musk now holds all the moves––handed to him by the Twitter board

The other interesting piece here is that Musk waived due diligence prior to signing the merger agreement, and relied on Twitter’s publicly-available financial and customer growth data, without access to internal books.

But the no-due diligence arrangement may also backfire. The agreement requires that all of the information publicly disclosed by Twitter prior to the signing be accurate. In his first tweet, Musk suggested that’s not the case. He’s questioning whether Twitter’s “fake accounts” really amount to under 5% of users, as it reported. “Musk is really saying that the public information we relied on may be wrong,” says Woolery. “Therefore, I can leave without even paying the $1 billion breakup fee! Instead of facing a more than $40 billion liability, he’s facing something between zero and $1 billion. That fundamental point changes the entire dynamic in a price renegotiation.” Woolery notes that Twitter has fired a number of top ranking executives, and risks that ex-employees could provide information regarding their customer counts and or the quality of their public disclosure. “All in all, it’s a terrible setup for the Twitter shareholders,” he concludes.

What Musk may be plotting

The board’s failure to hold Musk responsible for the full purchase price if he simply breaches the transaction puts it in an extremely weak position. Key employees are leaving. Tech stocks have slid sharply since Musk first bid. Still, it will be difficult for Musk to offer less than the $39 where Twitter sold before he arrived. The best bet may be that Musk tries to reprice the transaction in the low $40s, shaving as much as 25% or $11 billion from his $46.5 offer. Twitter, in fact, was trading in that range in mid-afternoon on May 13. Keep in mind that Tesla investors hated his Twitter adventure, since the prospect its CEO would be distracted rescuing a loser would severely damage the EV-maker’s future performance. That explains the big drop in Tesla’s shares, and the strong rebound on May 13 when he tweeted that Twitter may be a no-go.

So Musk might choose to end all the craziness, the worries over margin loans, the doubts about who’s steering Tesla by just getting out. By Musk’s standards, it wouldn’t cost him much, not more than the $1 billion breakup fee that’s a tiny fraction of his net worth, and perhaps not even that. The options are all on Musk’s side, and it looks like the maverick planned it that way. Musk claimed to chase Twitter to realize the ideal of creating an open public square. Who’d have thought he’d be beating the Wall Street pros on their own chessboard.

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