You’ve probably read about how such big hitters as Carl Icahn’s Icahn Enterprises, Dan Loeb’s Third Point and D.E. Shaw cleaned up when Elon Musk did a shocking about-face, and agreed to purchase Twitter at his original bid. But as a case study in why purchasing Twitter stock after Musk tried to exit and the shares tanked presented a such great arbitrage opportunity, it’s fascinating to study the reasoning of the two money managers who virtually wagered their small fund on the deal’s outcome, and won big time. Ryan Ballentine and Evan Tindell met in the early 2000s at MIT, where Ballentine captained the hockey and lacrosse teams, and Tindell captained tennis as a three-time All-American. Tindell even tried his hand at professional poker before the pair aimed at goals and aces playing stocks by starting Bireme Capital in 2016.
Bireme manages a portfolio in the $50 million range, mainly for individual investors, but Ballentine and Tindell give the ball a special spin by running it as a hedge fund. They specialize in finding situations where “cognitive biases” cause a stock to sell either well above or far below its fundamental value. Cognitive bias is a term from behavioral finance, the discipline positing that investors frequently make irrational decisions for reasons of comfort, habit or emotion.
One of Bireme’s big positions is a short on shares of Michael Saylor’s MicroStrategy, the enterprise software player that’s strapped its fortunes to Bitcoin by packing $3 billion in the crypto leader on its balance sheet. Ballentine and Tindell reason that its shareholders way over-value MicroStrategy based on its market cap’s premium over the market value of its Bitcoin. They also observes Saylor’s flamboyant salesmanship has tricked investors into vastly overpaying for the stock. In behavioral economics, it’s what’s called “the bandwagon effect,” where the more people who keep praising a stock or product, the more people get captivated by the growing excitement and join the herd. As Ballentine put it, “We like situations where people push a stock much too high or much too low for non-economic reasons, anticipating that the economic reasons always win.”
Why the Twitter drama was a clear case of mis-pricing
Ballentine and Tindell first bought Twitter when Musk posted his infamous “deal on hold” tweet on May 13. Until that date, Twitter was selling at a modest discount to Musk’s $54.20 or $44 billion offer. But over the next four trading days, its shares cratered from $47 to $37 as Wall Street saw a high probability the deal wouldn’t happen. As investor pessimism grew, Bireme bought more. Ballentine and Tindell re-loaded in early July after Musk’s letter to Twitter’s board pulling the offer sent shares to $33, and made their final purchases in late July after Musk filed counterclaims that in their view, revealed no new facts to strengthen his case. Although they decline to specify their holdings, Ballentine disclosed that the buys totaled well above $10 million, and that their investors have reaped “several million” in gains at Twitter’s price of roughly $51 at mid-morning on October 6.
For the pair, the doubts that drove Twitter’s shares into the mid-to-low $30s didn’t come close to matching the real odds the deal would close at the original price. “It was ‘cognitive bias’ in spades,” says Ballentine. “It was all about the glaring light and deafening noise around the transaction, and not about rational analysis.” What misled investors, he says, was Musk’s image as a winner, and his vaunted reputation for escaping trouble. “People looked at Musk, this genius in the public eye, as someone who told the SEC to buzz off and got away with tiny fines,” says Ballentine. “They looked at his history, and saw a big public face who always got his way. People assumed that would be the case in this dispute.”
Ballentine and Tindell based their conviction that Twitter would beat the world’s richest man on tangible evidence, the record of the Delaware courts in requiring buyers to honor purchase contracts and close on mergers. “People who thought Musk would win didn’t understand the Delaware Court of Chancery and how these cases are adjudicated,” says Ballentine. “The franchise of the Delaware courts is that they demand that contracts be enforced. Musk couldn’t tell the court to go away the way he summarily ignored the SEC. Being a scofflaw wouldn’t work in Delaware.”
Musk insists that Twitter was hiding its practice of allowing millions of “bots” and spam accounts on its platform. He argued that the multitudes of fake customers undermined its value so severely that they constituted a Material Adverse Effect that empowered him to scrap the deal. But Ballentine and Tindell didn’t think Musk’s claims remotely proved an MAE. “If you look a the case law, you see that only once has a buyer been able to break a deal via an MAE, and that was Musk’s principal position,” notes Ballentine. “His evidence for a real MAE was severely lacking.”
Ballentine emphasizes that in the sole instance where the Chancery Court allowed an MAE, the facts looked nothing like the Twitter case. In April of 2017, German pharmaceutical manufacturer Fresenius agreed to purchase Illinois drugmaker Akorn for $4.5 billion. In the months that followed, Fresenius discovered that Akorn had fabricated data to the FDA and committed fraud in failing to reveal its perilous financial condition. Akorn’s started booking big losses; in effect, Fresenius was buying an empty shell portrayed by Akorn management as a thriving manufacturer. Fresensius sued to quash the merger, alleging an MAE. In a blockbuster decision the following year, the Chancery Court opened the exit ramp for the first and only time in its history, and Akorn soon declared bankruptcy. It was clear to Ballentine and Tindell as the Twitter-Musk case unfolded that Twitter wasn’t hiding its true financial condition at all, and that Musk chances of proving an MAE, given the practically lethal damage the buyer had to show in the Akorn case, were nil.
On the issue of bots, the testimony of the whistleblower, former chief security officer Peiter Zatco, proved a fizzle according to the Bireme partners. “He was actually helpful to Twitter’s case,” says Ballentine. “He acknowledged that Twitter knowingly allows bot and spam accounts, but said that they remove them from the numbers that matter. That’s the count of mDAUs or monetizable daily users that drive advertising dollars.” A more plausible, but sill minor threat was the whistleblower’s account of multiple security lapses. “They sounded serious, but the main point is that they couldn’t possibly add up to a MAE that would kill the transaction,” recalls Ballentine. “The biggest fine of all time for information security practices was the $5 billion imposed on Facebook, a much bigger company than Twitter. A permanent destruction of value of over 20% triggered the MAE in the Akorn case. An impairment of that size would have meant that security problems hammered Twitter’s value by $12 billion, an implausibly large number.”
Well before Musk’s stunning reversal, Twitter’s shares rose well into the mid-$40s, far above Bireme’s purchase price. “As we expected, what happened over time is that people got news of the Chancery Court’s practically uniform record of enforcing merger contracts,” says Ballentine. “Law professors assessed the odds the deal would close at near the original price, and they mostly put the chances as overwhelmingly high. The rulings in the case were all in Twitter’s favor, it was obvious that the judge had a low opinion of Musk’s case.”
Possible reasons why Musk changed his mind
Though Musk faced a likely loss at trial, Ballentine was surprised by his sudden shift from demanding a full exit to, in all probability, paying a full price. “I thought since he’d gone this far that though he didn’t think he’d win, he’d go through with the trial hoping something would fall into his lap,” says Ballentine. “He clearly didn’t want to be deposed. He’d already used a lame excuse to delay a deposition for a week.” Ballentine reckons that a deposition could unearth a number of facts that could kill Musk’s case, and sully his reputation. “Musk used encrypted ‘signal’ messages in communicating with his family office,” says Ballentine. “He says he didn’t use them to talk about Twitter, but what if he didn’t disclose or destroyed signal messages about the deal? He’d also have to answer questions on whether he’d tried to scuttle the financing in a bad faith effort to terminate the transaction.”
As of October 6, Twitter was selling at $51, a nearly 6% discount to the contract price of $54. Ballentine and Tindell sold a portion of their shares, but still hold the majority on the conviction that Musk will close at the contract number. Still, Ballentine acknowledges that for that to happen, Twitter needs far stronger assurances from the Musk camp. “There’s lots of bad blood between the two parties,” he says. “Twitter regards Musk as untrustworthy. To make sure the deal happens, it will need to keep the trial scheduled until it received ironclad guarantees. One would be Musk’s putting tens of billions of dollars in escrow. Another would be for Musk to agree to an order of “specific performance” outside of a trial, meaning he would assume an adverse outcome from a trial. That agreement would would leave him no avenue to back out.”
The possibility the lenders will bail, scuttling a deal
“The lenders desperately want out of this deal,” says Tindell. He notes that interest rates have risen sharply since they committed to low-cost financing months ago, meaning they’d face big underwriting losses, and that the deterioration in Twitter’s business makes it a credit risk. Technically, Musk could escape from the deal if the creditors depart. But the contract stipulates that they can only walk if Twitter is insolvent, and its condition is far from that dire. Plus, evidence that Musk has prodded lenders wouldn’t fly with the Judge, Kathaleen McCormick, who in a previous case forced a buyer to perform after it conspired to kill its financing as a way out. “The banks appear locked in, but even if they somehow managed to escape and it were proven that Musk pushed them, the court could demand that he close by substituting his own billions for the loans,” says Tindell. He and Ballentine also agree that walking would tarnish the lenders’ reputations. “Their customers want to see the lenders they know and trust follow through on deals they committed to, and not wriggle out,” says Tindell.
How does Ballentine, who’s been closely watching Musk’s machinations in the Twitter saga, think he’ll fare as its owner? “He’ll find running a social media empire a lot harder than he expects,” predicts Ballentine. “It’s one thing to send rockets to the moon, but another to deal with messy social and political issues of Twitter. He’s a tech expert, not a social or political expert.” Not to mention that he’s overpaying by billions and dragging close friends along with him in what appears to be one of the worst deals in modern memory.
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