Musk has promises to keep, and new obstacles in his Twitter quest
A loose confederation of libertarian-leaning Musk lovers ponied up. But now the SEC is looking into the bid and Musk's Tesla stock, a big part of making the deal happen, is crashing.
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Everyone but Elon Musk has stepped back to assess whether his deal to buy Twitter will actually happen. To borrow a phrase from the poet Robert Frost: Musk has promises to keep, and months to go before he can tweet in private as the new owner. Twitter users also have months to go — the deal is expected to close in October — before we’ll sleep soundly again.
Musk isn’t known for holding his Twitter finger or for patience so there’s been talk he’ll pay the $1 billion deal breakup fee to call the whole thing off if the process becomes too tedious or his Tesla stock keeps crashing. I continue to seriously doubt Musk will follow-through and overcome the many legal and regulatory hurdles — some of his own making — for the deal to close in five months.
Elon Musk struck a deal with Twitter’s Board to acquire the company and take it private, but he used loans against his stock in Tesla and plans to spend billions more of his own cash along with raising money via a lemonade stand — kidding, it’s a motley crew of investors of various shapes, sizes, and denominations — without ever looking under Twitter’s financial hood.
On May 10 Bloomberg reported that in addition to the commitments from a roster of libertarian-leaning leaders — The New York Times euphemistically says Twitter investor Marc Andreessen is like Musk a "free-speech enthusiast and a backer of crypto technologies" — Apollo Global Management Inc. is now poised to lead a preferred financing for Musk’s proposed Twitter buyout. Citing the usual “people with knowledge of the deal”, Bloomberg says the funding, arranged by Morgan Stanley, will exceed $1 billion and may include Sixth Street Partners, among other firms.
That brings total commitments to about $8.1 billion including $1 billion from Larry Ellison and a flip-flop from Saudi Prince Alwaleed bin Talal, originally anti-Musk, who agreed to roll the dice, I mean roll his $1.9 billion of Twitter stock into the privatized company.
The Bloomberg report called the deal “brash” because it “came together at breakneck speed in part because Musk waived the chance to look at Twitter’s finances beyond what was publicly available,” writing off such behavior as “how the billionaire works.”
That sounds like how the billionaire individual and family office investors in Theranos operated, investing with very little due diligence and no financial audits. We see a repeat in the Twitter investor list of a few like Larry Ellison and Steve Jurvetson. Some with less money to burn sued Theranos successfully and Elizabeth Holmes was recently convicted of criminal charges for defrauding some others.
It’s highly unusual for an individual to make such a huge, socially significant acquisition without doing any due diligence, using only publicly available financial information to support your bid, according to George Mason law professor Jordan Neyland.
Maybe not so unusual for this crew, though.
Bloomberg reported that not only did Musk waive looking at anything but Twitter’s publicly available financial information but he also didn’t get a peek at a valuation analysis prepared by Twitter’s advisers, which included Goldman Sachs Group Inc. and JPMorgan Chase & Co., that was presented to the board last Friday, given the decision to bypass reviewing Twitter’s books and records.
To me that means Musk and his deal buddies will, and should, have to answer a lot more questions, from Twitter’s shareholders, Tesla’s shareholders, and regulators before this is a done deal.
That seems to be happening.
The Wall Street Journal’s Dave Michaels reported on May 11 that the SEC is investigating.
The Securities and Exchange Commission is probing Mr. Musk's tardy submission of a public form that investors must file when they buy more than 5% of a company's shares, the people said. The disclosure functions as an early sign to shareholders and companies that a significant investor could seek to control or influence a company.
The Tesla Inc. chief executive made his filing on April 4, at least 10 days after his stake surpassed the trigger point for disclosure. Mr. Musk hasn't publicly explained why he didn't file in a timely manner.
Mr. Musk likely saved more than $143 million by not reporting that his trades had crossed the 5% threshold, said Daniel Taylor, a University of Pennsylvania accounting professor, since the share price could have been higher had the market known of the billionaire's growing stake.
The Delaware Chancery Court opinion regarding Tesla’s acquisition of Solar City came out in favor of Musk. The plaintiffs may appeal, given the judge’s comments that Musk was more involved in the deal than he should have been, but that takes one spinning plate out of the air for now.
Twitter accepted Musk’s “best and final” offer two days before announcing first quarter earnings, a loss again if it hadn’t been for a significant gain from the sale of its MoPub unit. Twitter’s closing price on March 28, a month before the bid of $54.20 was accepted on April 25, was $39.12.
Perhaps the Twitter board knew it was not getting a better offer — none had come in after Musk’s announcement he had accumulated nearly 10% of the company in secret. Maybe Musk feels reassured about Twitter’s public numbers because they are audited by PricewaterhouseCoopers, the same firm that provides audit opinions for Tesla, the company short sellers have been unrelentingly criticizing for years.
Academic research published in the Journal of Accounting and Economics, Shared Auditors in Mergers and Acquisitions, provides strong evidence that a conflict of interest can occur when parties share an auditor during a merger and acquisition transaction. The study found that deal premiums are approximately 4.2% lower than the average premium of 47% in deals with shared auditors. The authors suggest the impact of a shared auditor can be economically meaningful. Musk’s bid represents a 38.55% premium over the price a month before, 18% less than the average premium when deals don’t share an auditor.
There was a huge run-up between the time Musk had purchased 5% of Twitter’s shares — on March 14 the price was $33.03 — and when Musk publicized the bid — April 13, the day before announcement when the price was $45.85. Neyland told me this makes measuring the premium Musk offered more complicated. Measuring before or after the run-up changes the premium offered by 39%!
Run-ups in the sample tested by the authors were around 5%. The run-up is also consistent with information leakage, but could also be price pressure from Musk's trades or that market expectations of Twitter being taken over or subject to activism were increasing the expectation of a share price increase, said Neyland.
The impact of this potential conflict is strongest when both audits are serviced from the same office, where the authors say there’s an additional 10% deterioration in the premium paid under that scenario.
Twitter is certainly much smaller than Tesla — Tesla’s market cap of $764.43 billion is 22 times larger than Twitter’s of $34.56 billion as of May 12 midday — but Musk is arguably the true “client” PwC really wants to please. (Tesla’s market cap has been dropping like a rock making the deal much more expensive given its heavy dependence on Musk’s share ownership and ability to sell Tesla shares or margin them. It was $932 billion on April 26, when I created a first draft of this piece.)
Tesla’s chief accounting officer is a former PwC auditor from its San Jose, CA office and the Tesla audit is signed by a PwC partner out of San Jose. The Twitter audit is signed by a PwC partner based in San Francisco who used to be based in San Jose. Of course partners who want to “confer” with each other don’t have to be in the same office, in fact most are rarely in an office at all anymore, but that’s close enough to raise the possibility of information sharing, said one former auditor who worked with all of the personnel involved. That’s consistent with the research conclusions, says George Mason University law professor Jordan Neyland, one of the authors.
“Bidders that share auditors targets have an informational advantage relative to competing bidders. They may leverage this advantage into a better bargaining position with the target since other bidders have less information and less incentive to bid, thus reducing bid competition,” Neyland told me.
What’s funny strange, not ha ha, is that despite the significantly larger market cap, revenues, and assets at Tesla versus Twitter, the fees PwC charges to audit each of the two firms are quite high and nearly the same for the period since Twitter has been a public company, 2014 through 2020. (Tesla’s proxy with its 2021 fees is not yet filed with the SEC.) That’s because Twitter spends quite a bit with PwC for tax services, a non-audit service that can sway an auditor’s objectivity.
The SEC is investigating the Big 4 public accounting firms for that, too, in particular as it relates to auditor independence issues that develop when auditors provide extensive tax services.
Tulane University law professor Ann Lipton told me that the only obligation for Twitter’s board in an all cash offer was to make sure Musk had the cash. The refinement of his funding sources forced the board to talk to him more seriously and then agree. But the board can still ask Musk to disclose more about any active investigations by regulators including by the U.S. Securities and Exchange Commission (SEC) and the Department of Justice that could present a risk to the deal.
For example, you may see a monkey wrench thrown into the deal if Musk knows but has not disclosed, yet, that the SEC or DOJ is serious about insider trading charges against him and his brother Kimbal or that Musk knew more about the SEC investigation of alleged violations of SEC disclosure rules as he amassed a stake in Twitter earlier this year that has not been disclosed.
The Twitter board must also look at whether regulators in any of the major markets it operates would object to a Musk take-private proposal where he owns a controlling share. William Kovacic, a long-time member of the Federal Trade Commission who was its General Counsel, a member and then its Chair, told me, "I do not see a basis for antitrust enforcement, even with an expansive view of the aims of merger control, to reach this transaction.” But the FTC wil do a review anyway.
However, any merger requires filing of preliminary proxy and the SEC has the option of screening it and offering comments. “I bet they screen this one,” Ann Lipton told me.
The SEC will be technically reviewing for full disclosure. They rarely are in a position to stop a deal, but it has happened. When Hertz wanted to raise equity in the midst of a bankruptcy the SEC said no and Hertz had to cancel the deal and take out a loan instead. In July 2021 the SEC halted The U.S. Securities and Exchange Commission has halted initial public offerings of Chinese companies until they provide more disclosures about investment risks.
The SEC can refuse to “accelerate a registration's effectiveness” meaning approve its IPO if they don't like what the company is telling them. That happened in 2012, when the SEC pressured private equity firm Carlyle Group L.P. to drop a mandatory arbitration requirement before it would approve its IPO plans.
What could the SEC object to in a proxy filing for an acquisition of Twitter by a group led by Elon Musk? Well, the SEC may not be thrilled with the way Musk handled the Tesla “take-private” attempt or how he violated its disclosure rules related to this one. If everything about the risks of a takeover by Musk are not disclosed, including what Musk has not disclosed in tesla fillings, the SEC may slow his roll.
The SEC could prevent Musk from being an officer or director of a private Twitter, as it did with Elizabeth Holmes and Theranos, if it proves Musk has violated SEC disclosure rules either recklessly or even worse, with intent.
The Twitter board did not get Musk to pay a higher price and didn’t get a go-shop period —where the company could solicit other offers. In exchange for taking on all of this Musk-specific risk, Twitter’s advisers reportedly got a higher-than-average reverse breakup fee, which means Musk will have to pay them more if he can’t complete the deal. Given he’s the richest man in the world, I think that will provide Twitter shareholders cold comfort.
Ann Lipton was certain some disgruntled shareholders would sue over the merger and find some reason to say disclosures are inadequate. It’s not that that doesn’t happen in almost every merger nowadays, “but this case is more serious.” Shareholders can file a “220 demand”, which is a request to the court to force the company to show its books and records.
Law firm Skadden Arps describes Section 220 of the Delaware General Corporation Law, as one that “allows stockholders to access to corporate books and records for a ‘proper purpose’ ― most commonly to ‘investigate wrongdoing’ such as a possible breach of fiduciary duty by the board or management.” Shareholders must demonstrate a “credible basis” for suspecting wrongdoing or mismanagement, but Skadden says that threshold is generally a bar to bringing suit.
Lipton told me that shareholders can use the results of a request “to file the substantive claim, either as a pre-merger disclosure claim or a post-merger claim that disclosures were inadequate and board violated its duties. They may not win on the merits, but I would be surprised if someone didn't try.”
Lipton had a crystal ball.
And another euphemism for libertarian.
© Francine McKenna, The Digging Company LLC, 2022
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