Is Twitter Going to Go Bankrupt?

Email agenda:

Estimated read time: 5 minutes 41 seconds

1. Acquiring a Company with Debt 101

2. Why The Twitter Acquisition Looks Quite Terrible Financially

3. Advice to Founders, Business Owners, and You and Me (Markets Over The Next 6-8 Months)

Good morning and happy Monday - let's get smarter

Acquiring a Company with Debt 101

Before digging a bit deeper into Elon's acquisition of Twitter, it first makes sense to cover a few M&A/debt topics to better understand the Twitter deal

When private equity firm, or business, or person buys another business, they are typically using a combination of debt and equity to fund the acquisition -> known as the sources

Similar to buying a home, most people don't pay in all cash, they use some debt from the bank and some of their own money for the down payment

In the buying a house example: your sources are your cash + the debt from the bank (mortgage) and the uses or use of those funds is for buying the house

In M&A, your sources can be various tranches of debt with different debt terms (interest rates, collateral, when the debt is due)

• Bank debt at a low interest rate

• Debt from a financial firm at a higher interest rate

Then -> any amount leftover for the acquisition that isn't financed by debt would be the equity amount that comes out of the buyers pocket, just how your down payment on a house would be your initial equity in the house

Then as you pay down the debt, your equity goes up -> same thing here

Quick lesson on debt: Debt in the sources table is typically listed by seniority. Basically, if this company goes under who gets paid out 1st, 2nd, 3rd etc. If you are 3rd or 4th in line, you probably want a higher interest rate for the risk you have of not getting paid back

In a big acquisition, you will often have multiple different lenders giving you varying amounts of debt to fund the acquisition, each with different terms and different seniority

In M&A, your uses go towards buying the company (Purchase of Enterprise Value in below), paying advisor fees, paying financing fees, could go towards putting a certain of cash in the business

This is called the sources and uses

The important point to understand here is you are going to pay down the debt you used to buy the business with the businesses cash flow

Think EBITDA (proxy for cash flow) - principal and interest owed to your lenders

The lenders know that in order for you to pay them back (principal) plus their interest, the business needs sufficient EBITDA

In the above cash flow statement, you can see MANDATORY REPAYMENT

These are the principal payments you'd have to make yearly on the debt for your acquisition

Then you can see how your cash balance changes over time, so you can see in your projections model, if we have to pay x amount of debt, will we have the cash to afford it?

The debt will have certain covenants (restrictions) such EBITDA/Interest ratio that you need to maintain throughout the year, otherwise it could trigger 1. the whole debt being due 2. more interest (all bad things for the buyer)

So if for the acquisition you take on too much debt and don't have sufficient cash flow's to make your principal and interest payments to the lenders who financed your acquisition, your lenders get squirrely

The advantage of using debt is, the business scales, but the fixed payments don't, so it massively increases your returns the more debt you take on

INSERT ELON BUYING TWITTER

Why The Twitter Acquisition Looks Quite Terrible Financially

Especially for the lenders

Going off of our earlier debt lesson about seniority, here is an important debt lesson before we get into the Twitter deal

Secured debt vs unsecured debt

Secured debt = collateral

Unsecured debt = no collateral

What this means is typically the highest seniority debt will have 1st lien (often called 1st Lien Debt in the sources schedule), meaning they have 1st claim on the inventory or equipment etc (assets)

Think of it like your car - if you don't make your payments, someone can come repo it because the loan agreement you have with them, the car is collateral if you don't make your payments

As I mentioned above, you often have multiple lenders funding the acquisition like in Twitter's case, and when you get to the UNSECURED lenders, the ones who don't have any collateral to claim

If you are unsecured and don't have collateral, you want a FAT interest rate

Twitter Deal

For Elon's acquisition of Twitter, Elon had about $13 billion in various debt to fund the $44 billion purchase price (use of funds)

Most of these loans, are floating interest rate loans (variable)

The floating interest rate is usually quoted in "SOFR + x%"

This means the SOFR, which you can pull from google to see how it's changed, The Secured Overnight Financing Rate + 2% = your interest rate

If the SOFR is 0.20% in the above example, your interest rate would be 2.20%

The SOFR is the average interest rate at which institutions can borrow the US dollar overnight

The SOFR is variable and is constantly changing

What does this mean?

This means that as interest rates change up or down, the more interest will be owed to these lenders

In April when Elon announced the deal SOFR was 0.30%

The SOFR today is at 3.80%.... meaning just between April when the deal was announced and October when the deal closed, Twitter owes $455 MILLION more per year in interest than he did when the deal was announced ($13 billion in debt x (3.80% - 0.30%)

In the trailing 12 months prior to Elon buying Twitter, Twitter did $5.2 billion of revenue and $421m in normalized EBITDA (cash flows), so 8.10% EBITDA margins (EBITDA/Revenue)

So the last 12 months Twitter had $421m in cash flow and just in SOFR increases they have $455m more in INTEREST

Based on the recent news of advertisers pulling money out of Twitter post

2023 Projections for Twitter

So based on the knowledge we have from above, let's take a look at what the financials of Twitter may look like in 2023

Revenue - If we assume the 80/20 rule, let's say Twitter's revenue will be 80% of what it was (.80 x $5.2 billion)

2023 Revenue $4.2 billion

EBITDA Margins of 10% (assume they got better from firing a ton of people up from 8%)

2023 EBITDA $420 million

Interest Expense

Based on the 3 terms on the 3 tranches of debt used for the acquisition, and what we know about SOFR ^, here are the estimated interest rates

• 1st Lien Debt: $6.5 billion loan -> interest rate of 15%

• 2nd Lien Debt: $3 billion loan -> interest rate of 19%

• Unsecured Debt: $3 billion loan (no collateral) -> interest rate of 22%

2023 Interest Expense $2.2 billion of interest

So $420 million of EBITDA (cash flow) and $2.2 billion of interest OWED....

Analysis - What This Means?

The analysis above takes into account a lot of assumptions, but a high level, it looks like Twitter will be BURNING cash fast

The lenders are so worried about not getting paid back that they are apparently looking to sell the loans to Hedge Funds and others at 60 cents on the dollar

Meaning -> Hey Hedge Fund, this $3 billion dollars we are owed from Twitter, if you give us $1.8 billion and we can walk away from this and lose $1.2 billion dollars, we'll do it!!

Why would the hedge fund do that? They are willing to take on the risk that Twitter will figure it out, and want to collect the massive amounts of interest expense from Twitter

What could Elon Do?

Elon could inject more his own cash or investors (this would be additional equity), but the issue is, no sane human is going to invest at that $44 billion valuation knowing all of this ^

So if they put in $10 billion and the valuation is cut to $20 billion, every single person that put in equity for the initial $44 billion acquisition sees their ownership get diluted down

Here's a visual example (assumes all equity no debt)

Elon and Bob put in $10 billion and $5 billion respectively for the $44b acquisition

The valuation drops to $20 billion, and new investor puts in $6 billion in equity

Elon and Bob's ownership drops 6.82% and 3.41% respectively, and their $10 billion and $5 billion became $7 billion and $3 billion

It will be very interesting to see what happens to the bird app over the coming months/year

Advice to Founders, Business Owners, and You and Me (Markets Over The Next 6-8 Months)

Brandon and I have been beating the recession drum for awhile

The economic outlook for 2023 does not look good AT ALL

If you are a founder or business owner

• Raise more capital if you burn cash, get 18 months of cash runway

• Analyze your entire P&L and cut any unnecessary expenses

• Built a base case forecast and a downside forecast, prepare for the downside

Advice for you and me

I am still buying the US dollar on down days and selling risk assets

Risk assets being stocks and crypto, reduce your exposure

Next up on the list of things to start buying in your account?

Investment grade bonds ($LQD)

Gold ($GLD)

These assets will generate you a return during this recession when other investors are losing 20%

You'll be making 10%, a 30 point swing

Don't let a bear market bounce fool you, winter is coming

- Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.