Elon Musk’s Twitter deal is different from most LBOs, here’s how

What’s the easiest way to buy something? With other people’s money. It’s the key to nearly every leveraged buyout (LBO) that has dominated mergers and acquisitions for a generation. Elon Musk’s planned $44 billion takeover of Twitter has seen many twists and turns, but after months of trying to pull out of the deal, since Oct. 3, the billionaire CEO of Tesla Inc. will moving forward again with the acquisition, which could close as early as the end of October. Although his privatization of Twitter is an LBO, it differs from most in several important respects.

1. What is an LBO?

LBOs are acquisitions where debt plays a crucial role. The basic idea is to buy a business with a combination of equity and new debt. But the key is that the acquirer, most often a private equity firm, doesn’t borrow the money – the target firm does. LBOs limit the disadvantages for the buyer: if things go wrong, it is the company that goes bankrupt, not the buyer. LBOs also increase buyers’ advantage as they can acquire larger companies than they could otherwise afford.

2. What is the leverage in most LBOs?

Private equity firms generally try to invest as little equity as possible in order to increase their potential return. But the limiting factor is usually the amount of debt the target company can repay without the debt payment dragging it down. The equity ratio is usually around 45% to 50% of the transaction. The word “leverage” refers to a special measure that compares the amount of debt to the profits of a company, and this ratio is usually high in these transactions. The upper limit is around 6 times, but it can go higher depending on the deal.

3. How is what Musk does different?

Musk is playing the role of the private equity firm in the leveraged buyout of Twitter. It is required to provide about $33.5 billion in equity, or about 72% of the total $46.5 billion in funding, with the rest coming from a pool of debt provided by major Wall Street banks. Included in this capital injection, Musk already owns more than 73 million shares, which are worth about $4 billion at a purchase price of $54.20. A group of 19 investors, including billionaire Larry Ellison, agreed to hedge an additional $7.1 billion of Musk’s $33.5 billion share. If Musk’s current stake in Twitter is excluded, his proposed purchase would be the fourth-largest deal in which a public company has been purchased and taken private.

4. Where do capital commitments come from?

Of the $7.1 billion paid to help Musk, about $5.2 billion comes from 18 financial partners who joined the deal; the other $1.9 billion will be generated by Saudi Prince Alwaleed bin Talal Al Saud who will renew his current Twitter stake, according to a May 5 filing. shares pledged by Musk in what is called a margin loan. Musk is worth more than $220 billion, according to the Bloomberg Billionaires Index, but most of it is illiquid. To raise more cash to fund his equity commitment, he could sell assets, including more Tesla stock. He could find more associates. He could also sell preferred stock on Twitter. It is a special type of stock that basically provides holders with additional benefits, such as high annual dividends. Musk had been in talks to potentially raise more capital from investors such as Apollo Global Management Inc. and Sixth Street Partners earlier this year, but those companies dropped out of talks months ago, around the time where Musk backed out of the deal.

5. How much debt would be added to Twitter’s balance sheet?

About $13 billion, the amount the banks have pledged to lend Twitter to complete its part of the deal. Twitter’s credit rating is already below investment grade, so this new debt would come in the form of junk bonds and leveraged loans. As is normal in LBOs, the intention was for the banks to then sell that risk in the form of longer-term debt to outside investors, but the banks are responsible and would have to shell out the money if something went wrong. . Based on the structure shown in the public filings, the pledges would likely be replaced by $6.5 billion in leveraged loans, $3 billion in secured junk bonds, and $3 billion in bond bonds. junk not guaranteed. The banks also provided $500 million of a special type of loan called a revolving credit facility that Twitter will be able to borrow and repay over the life of the loan.

6. Could debt financing fail?

Almost certainly not. Debt financing presents a headache – but for the banks, not for Musk. Led by Morgan Stanley, seven banks underwrote the debt, meaning they are obligated to provide the money, period. If banks fund the debt, they could potentially syndicate bonds and investor loans at a later date. But credit conditions have deteriorated since banks pledged to pay down debt in April, meaning they are likely to take a loss on at least some of any debt sales.

7. How much debt does Twitter have now?

Twitter has tapped into the junk bond market before and has two bonds outstanding for about $1.7 billion in total, as well as convertible notes. Twitter is likely to repay existing debt as part of the transaction. If the LBO takes place, Twitter will have billions of dollars more debt on its balance sheet. CreditSights, a credit research firm, sees total leverage increasing to a ratio of 9x an earnings measure, up from 3.7x previously, according to a report released on April 25.

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

The increased leverage means he will have little room for error going forward. Private equity firms typically load a company with debt, cut costs, and try to increase revenue. Profits must grow rapidly so that the company can pay its high interest and eventually pay off its debt. Some analysts predict the deal will leave Twitter heavily leveraged relative to its projected earnings, which could spell pain if the company can’t grow fast enough.

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