In mid-July, Evan Tindell and Ryan Ballentine, made a wager that veered far from their usual Benjamin Graham/Warren Buffett–inspired deep value strategy. The founders of midsize money manager Bireme Capital invested $9 million in a stock whose fundamental value stood well below where it was trading, but that they deemed was a lock to soon be sold for 40% more—at the full price that a wild man, mega-billionaire celebrity tycoon signed a contract to pay, in a horrendous deal he was now flailing to flee in an epic attack of cold feet. It was a sport these two warrior-athletes in their mid-thirties couldn’t resist: Tindell was a three-time All-American tennis star at MIT and tried his hand as a professional poker player, and Ballentine captained MIT’s hockey and lacrosse teams.
You won’t have to guess that they lined up to serve and took to the ice in the most watched, handicapped, mythologized takeover game in history: Elon Musk’s zany quest to dump the broken property that weeks before, he’d committed a king’s ransom to fix—Twitter Inc. (You can read Fortune’s full report on Musk’s Twitter quest here.)
Tindell and Ballentine bought their Twitter stake at between $35 and $36 a share around the time Musk shocked the markets on July 8 by declaring his intention to terminate his agreement to buy the social media giant at $54.20 a share, a price that valued it at $44 billion. On the news, Twitter tanked from $39 to the low- to mid-$30s. “Most investors were missing something big,” says Tindell. “We figured the chances the deal would close at $54.20 was over 90%, yet in the mid-$30s, investors were only giving it a 50% to 60% chance of happening. That was a huge gap between our view and the market’s view. You don’t get a lot of opportunities like that.”
For Tindell and Ballentine, investors were way overestimating the odds that Musk would prevail in the Delaware Court of Chancery, where Twitter was suing to force the Tesla CEO to pay the agreed-upon $54.20 a share. The court granted Twitter’s motion for an expedited trial that will begin on Oct. 17. “People were ignoring just how consistent the case history’s been in Delaware,” Ballentine tells Fortune. “Buyers trying to break deals won maybe once or twice in decades. Why was the view Musk would win so prevalent? Call it ‘Musk derangement syndrome.’ People were thinking, ‘It doesn’t sound like Musk has a case, but he dodges regulators all the time and gets away with everything.’ They’re wrong this time. The chancery court has a brand to protect, and that’s all about ignoring the personalities and the hype, and enforcing contracts.”
By early August, investors were shifting heavily to the Bireme partners’ take that Twitter harbored a much stronger case than Musk’s pugnacious but wobbly stance. The vast majority of legal experts agreed that the Delaware court would almost certainly remain true to form and force Musk to pay the full $54.20. The worst-case outcome for Twitter, securities lawyers agreed, was notching a settlement that avoided the remote chance of either losing at the trial or on appeal, at a share price no lower than the high $40s, totaling around $40 billion. By mid-August, Twitter shares had rebounded to roughly $45, reflecting extremely high odds of a full Twitter victory. Tindell’s and Ballentine’s investment was in the money big-time. The pair and the many other risk arbs who’d prospered on Twitter’s resurgence believed that by judging its shares in the mid-$40s, Wall Street had finally gotten the Twitter-Musk odds right, and the betting line had Twitter leading by two service breaks in the final set.
Whistleblower charges move the market—in Musk’s direction
On Aug. 23, a surprise twist arguably raised the chances, as viewed by arbs and other investors, that Musk could win. That morning, news broke that Twitter’s former head of security had filed a whistleblower complaint to the SEC, FTC, and Department of Justice alleging that the platform failed to protect sensitive user data and lied about security problems. Peiter Zatko also charged that Twitter’s leaders deliberately undercounted “spam” or false accounts. Since Musk’s case centers on the argument that Twitter is greatly exaggerating its paying customer count by hiding bots and other phony users, the Zatko explosion appeared to bolster his case, and money moved in Musk’s direction. By the market open on Aug. 25, Twitter’s shares cratered 11% from $44 two days earlier to $39, erasing $3 billion in market cap.
The big question is whether Zatko’s assertions, if correct, provide ammunition that could undermine Twitter’s case to the point where Musk could walk. If so, the relief to Musk and blow to Twitter’s shareholders would be staggering. Instead of paying as much as $44 billion for Twitter and owning it, Musk would pay either zilch, or no more than $1 billion or 2% of the contract number. A Musk win would leave investors with a weakling worth, by most estimates around half of what the Tesla founder agreed to and the sumptuous, inflated number the markets heavily expected when the whistleblower appeared.
Musk realized belatedly that he was way overpaying for Twitter. His $54.20 offer on April 14 was an almost 40% premium to the target’s selling price before the bid, and it was clear by late spring that the platform, plagued by flat revenue and soaring R&D expenses, was headed for big losses in Q2. Hence, Musk’s incentive to escape is overwhelming, given the gigantic hit he’d face as a loser in Delaware court. Musk is committing $26 billion of his own cash to the deal, and he’s raised another $7.1 billion in equity from a group of investors that includes Prince Al-Waleed bin Talal of Saudi Arabia and Oracle’s Larry Ellison. A group of banks headed by Barclays is providing around $11 billion in debt. If Twitter’s stand-alone value is roughly $20 billion as many analysts reckon, Musk position would be worth less than $12 billion, or $14 billion less than he invested, the day the deal closes.
“We’ve never seen a busted deal where a private individual who loses in court would take those kinds of losses,” says Eric Talley, a professor at Columbia Law School. “We’ve also never seen a case where the individual who could lose is the richest person in the world.”
The market may be overweighing the whistleblower’s charges
Talley has been handicapping the different possible outcomes, and establishing a “fair” price for Twitter aligned with those outcomes, since Musk started his campaign to exit. He believes that the whistleblower’s salvo raises Musk’s chances of prevailing only slightly, and the allegations don’t merit the 10%-plus pounding that’s pushed Twitter’s shares below $40 overnight. Here’s why. “I’ve read through the whistleblower’s filings in detail,” Talley tells Fortune. “The bot part of his statement supports Twitter at least as much as it supports Musk.” In his suit, Musk asserts that Twitter is way overcounting the bots in its measure of monetizable daily active users (MDAUs), customers who click on ads and hence generate revenue. “But that’s not what the whistleblower is saying,” notes Talley. “He’s supporting the view that Twitter doesn’t have many bots in its MDAUs, so it’s counting them correctly. Instead, he’s saying Twitter has tons of bots and fake users who are cheapskates and won’t click on ads in its total accounts. But he’s acknowledging that Twitter’s excluding most of those non-clickers from the MDAUs.”
In the case, Musk claims that Twitter’s disclosed estimate that false accounts amount to fewer than 5% of MDAUs is false, and that the real number is much higher. The whistleblower is confirming that Twitter’s MDAU numbers are more or less accurate. He’s simply saying that false accounts form a big share of the non-monetizable accounts. “Twitter never said that false accounts were less than 5% of total accounts, just of MDAUs,” adds Talley. So for Talley, the whistleblower isn’t alleging that Twitter lied about the bots and non-clickers. “He’s simply saying that MDAUs are a bad measure that Twitter shouldn’t be using, not that they’re lying about the MDAUs,” says Talley.
Talley and all the other legal experts I spoke to believe that despite the whistleblower’s broadside, Twitter still enjoys a high probability of winning in Delaware court. The rub is that even the small chance of a Musk victory before the new charges struck, and the incremental weight the whistleblower gives to his chances, exert outsize sway over where Twitter should be trading right now. The reason: The costs to Twitter’s shareholders of a loss are so gigantic—the difference between $54 a share and maybe $25 a share—that any sign Musk’s case is strengthening and that he might pay nothing will logically push Twitter’s shares far below the $50-plus price where the overall probabilities say he’ll pay. And that’s what happened. “When the magnitudes are big, even small changes in probabilities really matter,” says Talley.
Talley reckons that before Zatko blew his whistle, the market was getting the Musk-Twitter odds about right. But investors gave the new charges too much heft, and discounted Twitter’s stock sharply, while the legal balance shifted only slightly toward Musk. We’ll get to how Talley deploys an intricate decision tree showing all the possible outcomes and their odds, and where he sees the correct price today. But first, let’s examine what each side claims in the extraordinary legal case that pretty much can deliver only one of two outcomes, Musk pays $44 billion or nearly that, or Musk pays, at most, a tiny fraction of the contract price. The pivotal factors are the Delaware Chancery Court’s past record of ruling that a buyer must honor the contract and pay what it agreed to pay—and provisions in the merger agreement that could conceivably set Musk free.
It’s all about who breached the agreement, or whether Musk’s claims can kill the deal outright
The merger agreement between Twitter and Musk closely resembles a typical contract where a private equity firm buys a public company. “In many places, the provisions sound like they were cobbled together from a number of PE contracts,” says Rob Anderson, a law professor at Pepperdine University. In most PE deals, the buyer and seller both agree that when one party “breaches” the agreement, either by suing to terminate the deal or violating the contract, the non-breacher has the right to choose between two options: It can demand damages, or it can sue for “specific performance.” Damages in a merger agreement between two public companies usually means that, say, a jilted seller could collect the difference between the contract price, and the often-lower stand-alone value of the business once the purchaser leaves, a solution that would make shareholders “whole.”
But that’s not the formula in most PE mergers, and it’s not in this one. As in most financial buyer deals, the damages are capped in both directions. And the cap is $1 billion. “The cap is always a set number,” says Talley. “But in many deals, the damages a buyer who kills a deal would have to pay are much higher than what the seller who wants out would pay. The damages owed by the buyers can be as much as 9% of the purchase price,” says Talley. Hence, the damages that Twitter could impose on Musk are unusually low at a max of $1 billion.
For obvious reasons, Twitter chose specific performance over damages. Under specific performance, the court can order a buyer to pay the full contract price, in this case $44 billion, almost 50 times the number available from the other choice, a damages award that can’t exceed $1 billion. Twitter insists that it gets to pick specific performance because Musk “breached” by declaring that he was terminating the deal in July, sans legal justification. Musk claims that Twitter’s violations in effect void the contract, and therefore Twitter can’t pursue specific performance, and even may owe him $1 billion in damages. Musk is pursuing three paths to freedom. The first is proving a material adverse effect. He’s alleging that Twitter made false statements in its 10-K and other reports to the SEC, and that the misinformation amounts to an MAE. “He’s adding up what he considers false statements, and claims they reach the level of an MAE,” says Talley. “He doesn’t have to show that Twitter made the misrepresentations intentionally, only that they constitute an MAE.” Once again, it’s what he calls the vast understatement of bots and other false accounts in public filings that pile the stones to the level of an MAE.
Second, Musk accuses Twitter of committing fraud by failing to provide crucial information that would show it’s far weaker than it appears from the available numbers, and that its leaders have lied to him and his team about the bots and other damaging issues. Unlike proving an MAE, he’d need to show that Twitter acted “deliberately and with intent” in misleading him. The bar for “materiality,” or financial damage, however, is lower for fraud than for an MAE.
Proving an MAE would automatically void the contract and allow Musk to walk away. Winning on fraud would suggest that the contract was faulty and unenforceable from the beginning, and also cancel the agreement, setting Musk free. His third way out: Showing that it was Twitter, not the EV titan, that breached the contract by refusing to give him key information that the covenants obliged them to provide. In that event, Musk would become the non-breacher, and Twitter would be barred from seeking specific performance. Musk could either sue Twitter for $1 billion in damages, or simply leave unscathed.
But almost all legal experts believe Musk’s playing a weak hand. “On the MAE, he would have to prove that the published numbers are not only wrong, but that they are ‘material’ in that they have a devastating impact on Twitter’s finances,” says Ann Lipton, a law professor at Tulane University. “There’s little evidence that either one is the case. Musk’s making outrageous legal arguments that show he’s in a weak position. But he’s also so wild and erratic nobody knows what’s going to happen.” On the fraud angle, Musk would need to show that Twitter lied intentionally, that those lies once again hid heavy damage to Twitter’s financial standing, and that the problems were so well concealed that the buyers would be hard-pressed to find them in the course of normal due diligence. Of course, Musk famously waived due diligence in forging the Twitter deal. That decision, however, does not exempt him from overlooking problems he should have seen. “It doesn’t appear Musk has a case that Twitter lied about the bots in the MDAUs, or that even if so, the misrepresentations have a major impact on Twitter’s finances,” says Anderson from Pepperdine.
The Delaware Chancery Court’s remarkable record of enforcing specific performance
Musk’s biggest problem is the Delaware court’s almost unwavering practice of imposing specific performance—of forcing a purchaser suffering from buyer’s remorse to pay the full contract price and take ownership. In the past decade or so, in only one case have its judges allowed the acquirer to terminate a deal. In 2017, pharma company Fresenius Kabi AG of Germany agreed to purchase generic drugmaker Akorn for $4.75 billion. Then, a whistleblower complaint rightly accused Akorn of misleading the FDA on data for drugs pending approval. A company portrayed as healthy by its leaders was really a wreck. The Delaware judge ruled that Akorn was so far from the enterprise Fresenius thought it was buying, and that the buyer was so victimized by the seller’s deception, that it declared an MAE and allowed the German company to terminate the contract. Two years later, Akorn filed for bankruptcy.
In 2019, Boston Scientific claimed that it had grounds to cancel its deal to purchase Channel Medsystems when it received reports that a former Channel employee had stolen from the acquiree and falsified submissions to the FDA seeking approval for new drugs. The charges were true. But the Delaware court upheld Channel’s suit for specific performance, and forced Boston Scientific to close the $275 million merger. In early 2021, medical-device maker Hill-Rom refused to consummate an agreement to purchase BardyDx Diagnostics. Its reason: A change in Medicare rates that allegedly pounded Bardy’s profitability constituted an MAE. The court determined that the Medicare shift didn’t substantially hurt Bardy’s earnings power, and required that Hill-Rom honor the contract. The $375 million merger closed last summer.
Sometimes, a buyer’s perception that the case is moving against it, and that the courts are poised once again to mandate specific performance, will force them to settle, at close to the original price. LVMH-Tiffany is a case in point. Around Thanksgiving of 2019, the French luxury goods colossus unveiled a $16 billion deal for Tiffany. Hammered by COVID, Tiffany careened from strong profits to losing $32 million in the first half of 2020. That September, LVMH declared that it was backing out, and Tiffany immediately filed for specific performance. Fearing a Tiffany win in Delaware, LVMH in October secured a small discount of 2.2% or $425 million, and added Tiffany to its collection at the end of 2020.
The case that could most concern Musk is one recently decided by the judge who will preside in his case versus Twitter, Chancellor Kathaleen McCormick. In early March of 2020, just before the pandemic struck, Kohlberg & Co. announced a a $550 million pact for cake decorating specialist DecoPac. A month later, Kohlberg tried to ditch the deal, arguing that the COVID crisis had flattened DecoPac’s sales, and that the pandemic’s hit triggered an MAE. Kohlberg also argued that the target’s descent so spooked lenders that they withdrew support, forming another justification for scotching the deal. In a ruling that may echo in Musk-Twitter, McCormick determined that Kohlberg itself had undermined the financing in an effort to get out. She rejected the MAE claim as well. In May of 2021, Kohlberg bought DecoPac at full price.
Musk still has a couple of escape routes
And the chance one of those channels opens is holding Twitter’s price far below the $54.20 it will collect if the courts make Musk “perform.” But how much does the probability that Musk can free himself justify the gulf between Twitter’s current price and the $50-plus purchase that most experts deem most likely? First, let’s count the ways Musk would end his nightmare and either pay nothing or a pittance. Second, we’ll examine—courtesy of professor Talley—where Twitter’s price should be based on the odds of the different outcomes. “The litigation over the bots is a sideshow,” says Anderson. “The main event that carries the big economic consequences is the remedy that the courts will choose.”
Three ripostes could win the duel for Musk. First, he could conceivably show that Twitter, not the EV titan, breached the contract by failing to provide crucial information, or that the contract is null and void via an MAE or fraud. All three possibilities looked remote before the whistleblower appeared. As Talley points out, Zatko’s disclosures do nothing to bolster Musk’s position on bots. But he raises other potential problems for Twitter. “The whistleblower says that Twitter doesn’t own intellectual property it’s claimed to own, related to its algorithms,” says Talley. “Musk could say that he requested information on intellectual property, and was stonewalled or misled. He could say, ‘I asked for all this information, and they lied or didn’t give it to me.’ He could argue that the covenants in the deal gave him the right to key information they didn’t provide. So maybe the whistleblower’s filing could move the needle on one of his three claims.” And in that event, the contract would collapse, or Twitter would lose the option of suing for specific performance.
A second off-ramp would open if Musk loses his debt financing. The contract specifies that if Musk’s banks bail on their promised $11 billion in funding, he’s not required to close. “I consider this the most likely ‘out,’ but it’s still somewhat remote,” says Talley. It appears from Musk’s agreement with the creditors, however, that they can only depart if Twitter becomes insolvent or can’t cover future interest expense. Both are improbable, the latter because the deal is leveraged relatively lightly. Musk must tread carefully not to be viewed as pushing his lenders to leave. McCormick soundly condemned that tactic in her Kohlberg-DecoPac ruling.
In another bizarre wrinkle, Musk needs to provide a “certificate of solvency” to the lenders at closing, showing Twitter’s financial health is not endangered. “But believe it or not, it’s an entity controlled by Musk that’s slated to sign off,” marvels Talley. “Can you imagine if Elon Musk tried to kill the deal by refusing to sign his own solvency certificate! He’d have his own fingerprints on trying to kill the deal. That wouldn’t land well with Chancellor McCormick.”
The importance of an “I lost the lenders” escape: It would take specific performance off the table, a condition stated in the contract. Then, Twitter could only obtain damages, and the number is capped at the paltry $1 billion.
Another wild card: You just never know how a court will decide, even one as devoted to specific performance as Delaware Chancery. “The judge can decide the most ‘equitable’ outcome, and the outcome she chooses might not be specific performance, though it probably will be,” says Lipton. “She could consider the effects of enforcing this merger on the rest of the world, and that who breached the contract isn’t all that matters. She could consider the effects of forcing an erratic, unwilling buyer to purchase a company of this magnitude. She might consider that having Musk buy Twitter would damage its employees, and hurt an important public forum.” Lipton acknowledges that the “effect on the world” outcome is a long shot. But if McCormick were to choose that solution, she would be picking damages over specific performance as the right remedy. As in the vaporized financing scenario, Musk would probably waltz off after paying his foe just $1 billion.
Talley’s view of where Twitter’s price should be
Let’s go back to Talley’s decision tree, on display in the Columbia prof’s compelling recent videos. It sprouts sundry branches displaying every possible outcome, and assigns probabilities to each that when added together, show where Twitter’s price “should be.” Before the whistleblower’s haymaker, Talley put the chances that the court will find that Twitter wins at 90%, versus just 10% odds on Musk’s various outs. But even those long odds on a Musk victory influence the price smart investors should be paying a lot—because it also puts the chance Musk pays nothing or $1 billion or so at 10%, a not insignificant number. Talley also places around a one-eighth probability that defections by lenders make it impossible for Twitter to pursue specific performance. If so, the social media site could leave the courtroom collecting tiny damages of $1 billion instead of $44 billion. Because the hit from those two relatively small probability events would cost Twitter so much, Talley’s analysis awarded a probability-adjusted price of $46 before the whistleblower eruption. And that’s close to where Twitter was trading in the weeks before the fireworks.
But what does today’s price of $40 say about revised the probabilities the market’s now applying to the deal? According to the ingenious Talley model, investors just lifted the odds the court will find that Musk will eke out a victory first to around 30%. “I believe that’s much too high,” says Talley. “I would raise that number to about 15%. And at 15%, the price the decision tree arrives at is around $44, 10% higher than where Twitter stands today, but slightly below where it was before the whistleblower’s account shook things up.” In other words, the whistleblower just skewed the market odds that looked coolly rational a few days ago, and probably skewed them too much toward Musk. “Please keep in mind that these are just good faith estimates. It’s an estimate of what the rational price would seem to be,” says Talley. “There’s obviously lots of imprecision surrounding this entire pursuit.”
Like Talley, Ballentine and Tindell think that much of the whistleblower’s testimony actually supports Twitter’s case. “But it covers so much ground that it’s good for Musk on the margin. That’s because it increases the volatility of the situation. Musk is like an investor who’s holding an underwater option. He wants the most volatility possible so that he can get lucky and avoid a big loss,” says Tindell. The two sportsmen agreed with Talley that the market’s overreacted and that Twitter’s trading a bit lower than it should be. But they’re standing pat for now rather than buying. They still view Twitter as up two breaks in the final set. But suddenly their opponent is swinging away with reckless abandon, grazing the lines with topspin winners. He still looks like a loser. But with Elon Musk wielding the racket, and cussing out his opponent, you never know.
