Elon Musk Acquiring Twitter

EconBuff #38 with Eric McKee

Dr. Eric McKee talks with me about Elon Musk acquiring Twitter. Dr. McKee walks us through the differences between hostile and friendly takeovers. We discuss what steps are involved in a hostile take over. Dr. McKee explains the main three anti-takeover provisions corporations can take. Dr. McKee addresses so called “poison pills” and how a company can dilute their stock in order to prevent a hostile takeover. Dr. McKee lays out how a company can find another buyer to compete with acquiring agent, known as a white knight. We discuss staggered boards, where firms keep their board of directors from being up for election every year, thus making a hostile takeover harder by delaying when board members can be replaced. Dr. McKee evaluates the agreed upon purchase price and discusses why Twitter stock has not risen all the way to the agreed upon purchase price. Finally, Dr. McKee gives his thoughts on why Musk might be buying Twitter and relates it to firm life cycles, pointing out that Twitter is relatively young for a tech firm. We close by discussing activist investing.

Photo by Alexander Shatov on Unsplash

Transcript:

Stitzel: Hello, and welcome to the EconBuff Podcast. I'm your host, Lee Stitzel. With me today is Dr. Eric McKee. Eric is a professor of finance at West Texas A&M University. Eric, welcome back.

McKee: Thanks Lee, I'm glad to be invited back again.

Stitzel: I always love having you on. You seem to be my de facto current events. So much of what I do is kind of topical, and, like, loosely inspired by current events. And you and I just seem to have the knack to find things when they're happening. Last time we had you on it was the Game Stop Short Squeeze --- a very popular episode on the channel. I think we might even one up at this time. Our topic today is Elon Musk buying Twitter. A lot has happened in the last few days here. So, Musk bought in to Twitter 9.2% stake. That makes him the largest shareholder at the time, right?

McKee: I think so.

Stitzel: Yeah. So, you know, not….

McKee: The second largest.

Stitzel:…a trivial thing. And then for whatever reason, he thought that's not enough. I got to have the whole thing. And he offers to buy it for $44 billion dollars, right? Including $21 billion in personal equity. And that amounts to about 10% of his net worth. I mean, goodness, he's worth a lot of money. I'm really interested. So he goes and he offers to buy it at $54.20 a share. And then, Twitter was trading at around $39.00 right there. So, what I want to talk about with you today is, you know, the ins and outs of how takeovers work. And if we're not a finance professor, we say now we know about hostile takeovers [and] friendly takeovers. Where would you categorize this? Is it a hostile takeover?

McKee: Well it certainly started as one. So it was not a solicited offer. Twitter wasn't trying to sell itself to anyone. Elon Musk just, kind of, came out of nowhere and said: hey, I'll buy you. And then afterwards, they eventually negotiated an agreement. So, it just a couple days ago Twitter's board unanimously voted to approve the merger deal. So in the end, it ended up being kind of a not hostile takeover. But that is kind of how a successful hostile takeover would work, because there's a lot of ways you can play defense and prevent a potential acquirer if you want to (if you have the will to do it). And so normally, a lot of times with a hostile takeover, they'll start out hostile and then you have to, sort of, negotiate with the potential choir. And you come to some sort of agreement if it works out. If it doesn't work out, then you don't have the agreement of course.

Stitzel: So, the connotation of a word “hostile,” you know, it has like combat…

McKee: Yes.

Stitzel:…or aggressiveness…

McKee: Yes.

Stitzel:…in there. Is the way that we're using hostile (when we're saying hostile takeover) --- is that is it just kind of a word that means it wasn't solicited? Or does it actually mean something more to what the, like, intuitive meaning of the word hostile is?

McKee: I mean, so it's not as though like Musk wants to destroy Twitter. I mean, he wants to buy it and use it for his own purposes ---  potentially increase his wealth or whatever, you know, personal preferences he has. And what he wants Twitter to do --- he has not been super clear about exactly what he expects to change about Twitter. He has a few, like, ideas he's mentioned on his tweeting feed, but nothing, like, super concrete. But the, kind of, the war analogy I think it one way it makes a lot of sense is that what really matters is the will of both the acquirer and the target firm. Because if you have the will to resist like morale in war, then you can usually win as a defender. And the way you win is by eroding the will of the acquirer to continue to pursue that acquisition.

Stitzel: This makes finance sounds so human or something. I'd love to…

McKee: Well there's a lot of humans involved. There's always a human at the at the end of the chain --- even if there's lots of legal, you know, constructs.

Stitzel: So, just so I'm clear let me ask this question. So, I have a business. I'm going along doing my daily thing. And you're one of these Elon Musk types. And you think, you know, what I'd like to have Lee's business. And then you want to engage in a hostile takeover. If you make an offer, right, [and] if you come out of nowhere and say: look, I want your business, and I want you out on the street, you know, with a suitcase full of money tomorrow. And I'm like: yeah, let's do it. Then it's not a hostile takeover really, even if it's really….

McKee: Yeah. Even if it's unsolicited. I mean, if you just immediately agree to it, that's not what we would typically think of as a hostile takeover, yeah.

Stitzel: So, but our, like --- what then? How does a hostile takeover that the business being acquired is against? How does that unfold? Walk us through the steps of how we might see that happen?

McKee: So, I mean, some of the things Twitter did before they reached the agreement, kind of, pointed us there. So, there's a number of, basically, anti-takeover defenses that you can put in place, or maybe you already have in place. So, one thing Twitter did after Musk made his initial offer and built up the 9% holdings, is they put in place but what's popularly called the poison pill. It's technically a shareholder rights protection plan, which is actually more accurate than the poison pill. Because if you say it's a poison pill, you might think: oh, Twitter's going to commit suicide to stop the acquisition. That's not really what a poison pill would do. So, the poison pill is basically saying: O.K. Musk, if you buy more than I think it was 15%, --- but it's some trigger amount like x% (15% - 20%) of the shares outstanding --- then we're going to issue shares at a discounted price to every other shareholder except you. And so, that's going to dilute your voting power. So, if you try to just buy it up on the open market, you will just mathematically always fail, as long as we are willing to keep doing that shareholder protection plan or poison pill. So, it will mess up your share structure. You're going to be issuing shares at a lower price than it probably is worth. So, you're, kind of, losing money for your shareholders, but you're not destroying the company. So it's damaging. You damage yourself to stop the takeover. But it's not a complete everything that's, you know, thrown out and into the trash, all right? Not a complete suicide.

Stitzel: Poison pills and hostile takeovers. What an evocative set of ideas. O.K.

McKee: So there's lots of these --- that kind of imagery.

Stitzel: So, if Twitter didn't want to do that --- which I assume, kind of, circles back to what you're talking about is, like, a their will to resist ----

McKee: Hmm mmm.

Stitzel:…and so, they just, kind of, let things take their course, [then] Musk could just go buy around [or] go around buying up shares.

McKee: On the open market. Yes.

Stitzel: And that then he could be the…

McKee: Then he could buy more votes that he would just control the firm. Yes. So, like the shareholder protection plan poison pill --- that completely blocks them off from just going to the open market and buying up everything. And at least in like finance research, you know, there's some companies [that] have a poison pill on their books. Some don't. And actually, one of my advisors he actually has a paper where he's like: guys, it doesn't matter if they have it on the books or not, because they can always just instantly add it if they feel threatened. And that's exactly what Twitter did. They didn't have one. Then they felt threatened because suddenly Musk jumped in with 9% of the shares and he was making an offer. And they said: oh, we need this poison pill. And they immediately added it. So, yeah. It's --- that's one of the provisions that your firm could use. And it's basically always available for a firm. So, you could always add a poison pill if you want to, and if you think it's justified.

Stitzel: So, I have two questions then. Musk goes around, and say Twitter doesn't go with the poison pill policy. And Musk goes around buying up things. There are two questions that, kind of, jump out to me. The first is --- it's probably naturally going to get harder to acquire shares because as that strategy becomes known…

McKee: Yeah. Yeah.

Stitzel:…the price…

McKee: The price is going to start going up pretty [high], because, you know, it's supply and demand.

Stitzel: What's the matter? What's the mechanism?

McKee: He's eating, he's buying up all the shares that there's higher demand here, right? And then the supply of people who are willing to sell is, kind of, getting eaten up, because he's not going to sell his shares after he's bought of course.

Stitzel: So, yeah. He's raising the demand in this case. And he's having to find people to buy stocks from, who presumably, right, are what we call inframarginal suppliers in this case. And so therefore, they're going to have higher and higher thresholds that they would sell at, or willingness to accept in econ lingo. Is that? Is that kind of encompassing?

McKee: Yeah. Yeah. So, if he was just going on the open market --- a lot of times someone will in the choir will say: we'll make a tender offer. Well, let's say I will buy at a certain price and he sends it out to all the shareholders --- in this case it would be, kind of, an unsolicited one that the board isn't approving --- and, you know, if enough of the shareholders all collectively agree to sell at that price (that he has enough shares), then it would go through. Otherwise, it wouldn't go through. So, that's one way to structure it so you can avoid some of those issues where you're buying in [and] the price just keeps going up and up and makes it more expensive for you.

Stitzel: So --- second question then. He succeeds. He gets whatever of the shares that are available. What does he do then? How do you, sort of, complete the takeover into actually making decisions for the company?

McKee: And then you have to replace the board. And that's another place where there's a common, or it used to be common, anti-takeover provision which is having a staggered or classified board. The best example I can think of is comparing it to like the House of Representatives and the Senate. So, the Senate --- there's a six-year term. And roughly one-third of the seats is up for election every election cycle. And House of Representatives --- everyone's up for election every single cycle. So, if you have a staggered board, [then] you're like the U.S. Senate. Some other directors (maybe a third or half of them) will go up for election at the next shareholder meeting. The other ones won't. So, that means if you bought up enough shares to basically win an election, for who's going to be next directors next, [then] you can only replace some of them [and] not all of them. And that's another, sort of, anti-takeover provision. Generally in finance, we think those are bad for the firm. And there's been a lot of pushing on firms to get rid of classified boards, and make their boards always just a single --- everyone gets elected at once. I think Twitter has a staggered board. So, in that case, you might have had to wait a year or two, or two or three years potentially, before he fully had control of all the directors.

Stitzel: Why is it bad? I'm missing the intuition on why I would think that would be about.

McKee: So, it's basically related to corporate governance. So, if you have a threat of being acquired --- if you're acquired CEO generally gets fired. Top executives generally get fired. Current board of directors probably gets fired too. And so, if you're managing the company poorly, [then] the stock price is going to go down. The company's going to be an easy target to be acquired. And someone like, you know --- I know, Gordon non-fictional --- Gordon Gekko can jump in and buy your company for cheap, and, you know, that's bad for your personal [brand]. Personally, it's bad for you. So, that's a threat that forces you to, kind of, keep the firm doing well. So, it's one of many, many possible mechanisms we could have to try and improve corporate governance, [to] make sure that the managers [and] the board are doing a good job trying to run the firm well. The threat that they might get fired if they don't do a good job.

Stitzel: No.

McKee: It's not from the shareholders, but from someone else who sees them doing a bad job and says: hey, I can do better and you're cheap, so it's easy profit for me.

Stitzel: Turns out that's a good incentive.

McKee: So, that's the theory behind trying to get rid of, say, classified boards, and saying, kind of, any of these anti-takeover provisions are considered bad for corporate governance.

Stitzel: So.

McKee: Actual empirical support for that is a little bit more fuzzy because again, you could always just add a poison pill. So, it's not clear, like, if you have one does it really mean anything? So, it's, you know, empirically ---- it's always a little bit more fuzzy on exactly how beneficial or negative these particular provisions are.

Stitzel: It seems like the poison pill is going to be more costly than staggering your board probably. So, it makes it a little…

McKee: Sort of, yes. And but, it's also hard to measure because everyone has a poison pill. So, we don't have any variation in firms that some don't, some do, [because] they all it.

Stitzel: So, if we've if these elections come along, and so we want to replace a board member, [then] where does the other (where's the alternative) person that Musk wants to install? Where do they come from?

McKee: So, he might nominate himself. He might nominate friends and allies that he knows are going to agree with him. Basically, you know, people who will just do what he do what he tells them to, essentially. If you have an activist investor, who's trying to get a couple seats to change things, [then] they'll often either get themselves (or some direct subordinate of them) added to the board, or put up for election to be added to the board.

Stitzel: And then, the votes come along.

McKee: And you have the shareholders vote. And if you win that election, then yeah, your board member. You get the vote. And I need the decisions the board makes.

Stitzel: So, what's interesting about this [is] you don't really actually need a, like, full majority most likely; because I don't think everybody will actually...

McKee: Yeah. To win an election (a normal election), you [know] that most people don't vote. Most shareholders are not voting. It's there's not very many voters. Of course, if it's a contested election where, you know, you're trying to oust board members that the management doesn't want you to oust, then there might be a lot more votes than normal. So, it can be hard to predict, like, exactly how many votes you need. I mean, if you have 51% percent, you're gonna win 100% for sure. Yeah.

Stitzel: But, you, know there's a chance even with 40% or 45%.

McKee: But you could. Yeah. You could win without a majority. But interesting, if there are people that don't bother.

Stitzel: And so, if you're engaged in a hostile takeover, this is a calculation you're making. How much do I need in order to try to gain control?

McKee: Yes. Yeah.

Stitzel: And then once you have the board positions organize the way that you want…

McKee: Yeah. Once you have the board numbers working for you, then they'll just agree to sell the company to you for whatever price that you've, you know, that they've agreed on. Yeah. So, if you have control of the board, then you can basically force a company to do the merger then.

Stitzel: So.

McKee: Because you're --- you are yourself and you're also a company too, [and] because you own the company that is bad at that point.

Stitzel: So, O.K. this is interesting, because very interesting, sort of, strategically. Are there other ways to do hostile takeovers? This, kind of, what we mean when we say hostile takeovers? Just, like, mechanically the steps that we'd go through.

McKee: I mean, that's, yeah, trying to buy empty shares. And generally, I mean again, because there's a lot of ways you can play defense. So, get a position. Use that position as leverage to negotiate a deal is how a successful hostile takeover would probably work. It's generally gonna be pretty hard to just say I'm going to secretly buy up. Well, it's impossible to buy secretly up those shares, because if you do, [then] you're going to get huge fines from the SEC. You're required to disclose once you hit a, I think, it's 5% now. But once you have a significant amount of shares, you have to disclose that you you're a significant shareholder of that firm.

Stitzel: And that means what? Just that you have that number of shares? Not anything about your intentions?

McKee: Yeah. I don't think you have to say anything about your intentions. You just have to disclose that, yeah, I own, you know, 9% just like Elon Musk had to disclose his ownerships.

Stitzel: So, this is an interesting situation, because we're going to have lots of hostile takeovers I assume. But not many are being live-tweeted by the guy trying to do the takeover like we saw here. Elon Musk is actually tweeting live.

McKee: Yes, they're definitely not live-tweeted. Yeah. They're not, I mean, M&A’s are relatively, I mean, they're not super common. They do tend to come in waves. A lot of them are, again, not hostile. They’re a willing arrangement between the target and the acquirer.

Stitzel: And what do we call those? Those are just friendly?

McKee: Friendly, non-hostile. Yeah. They're --- it can be a little like hostile takeovers can turn into the friendly ones, kind of, like how what's happened with Twitter. So, O.K. the definitions are a little fuzzy.

Stitzel: Of course, right? Because it's --- this one's, like, started hostile. And then, you know, whose opinion matters in terms of being hostile? We see lots of, sort of, backlash from Twitter employees, right? But if the board is all for it, then it's not really hostile, even if nobody else in the company wants the takeover to happen, right? So, when you have a non-hostile takeover, we've already established that could in theory be unsolicited, but most likely the company is being put up for sale or actually, like, trying to approach buyers? Or how do we get?

McKee: Yeah. Sometimes you approach buyers. Sometimes someone has attempted a hostile takeover, and then you go out and find a different buyer who will pay more. That's called finding a white knight. That's another common, sort of, anti-takeover protection you can try to do. It's not like something in your bylaws. It's just you as the board go out and try to find a better offer. I think there were some reports that Twitter was, sort of, trying to do that, but they couldn't find anyone who gave a better offer than Musk.

Stitzel: And so?

McKee: And so in that case, you are, you know, you're going out and you're finding the offer.

Stitzel: What's up with that? Is that because the price tag is so high, or are just not that many people interested in Twitter? Or the timelines compressed? What's causing them to not be able to find?

McKee: I'm not, you know, privy to those high-level kind of conversations; but I obviously, they don't want to offer a higher price (kind of a duh thing). Of course, if they were, they would have done it. Or they're not. Or they're not willing to. They're not able to, you know, finance it and financing such a large acquisition can be can be tricky. Although for, you know, it's different because Musk is an individual. And most acquisitions are like a company's acquiring another company.

Stitzel: So, are anti-takeover provisions --- are poison pills, staggered boards, and finding outside --- I assume. Are there others? Are those kind of the main things?

McKee: Those are the main, those are, kind of, the most common ones. There's other things you can do or just basically sabotage your company. You can sell off pieces of the company to someone else. But maybe that's the valuable piece that the acquirer wants. You think of, like, a vulture capitalist who's going to come in and, sort of, break down the company [and] sell off the valuable parts. So, if you sell the valuable part before they come in, then there's nothing for them to take. Those are --- I don't remember [and] I don't think --- those areas common as, like, doing a poison pill. They're also, kind of, more irreversible and really more costly for the shareholders; because that's the will on the part of the board, is if they're resisting, [then] they're hurting their shareholders. So, and they have a fiduciary responsibility to their shareholders. And they can get sued over that. So, if they're --- not unless they can justify doing the resisting, you know, they're gonna  have some trouble legally. So, the more extreme and aggressive your defense is, the better your reasoning [should be]. Your reasoning needs to be better too, because you might have to justify that in court.

Stitzel: can you give us some examples of hostile takeovers? Some ones that we might have seen, heard of, or a lot of these happening? Kind of, it doesn't seem like this has a huge share of the collective consciousness.

McKee: Yeah. I can't think of any recent ones. They've gotten rare, because there's been court cases that say: yeah, you can do this poison pill whenever you want. You can have staggered boards. And so, I think my sense --- and this is just my, kind of, my personal sense here --- is that, like, it's harder to do a hostile takeover now than it was, say, back in like the 1980s. And we had these corporate raiders that inspired, you know, Gordon Gekko and Wall Street in the Wall Street film.

Stitzel: And the, kind of, things where we're looking at a company --- we're saying this is more valuable [because] you're, sort of, torn apart and sold off than it is constructed the way [it is]. That --- I think, that's probably what we think about most of the time [when] we think hostile takeover.

McKee: But that's not always --- that's often not even hostile. Like, a private equity firm comes in and says: we're going to try to restructure the firm and save it --- because it's your guys are about to go bankrupt and we need to do some desperate measures to try and fix it ---.doesn't always work, but often that's not really a hostile takeover. Like, they offer a pretty good price and the shareholders take it. And that wasn't, you know, done against the will of the board or anything like that; because again, like, the board can always resist pretty strongly if they want to.

Stitzel: So, most of the time when we see takeovers, right, it really is driven by a profit motive?

McKee: Yes.

Stitzel: And it feels like maybe this case is different…

McKee: Potentially not. Yes.

Stitzel:…than that, because it doesn't seem like Musk is necessarily got a bunch of great ideas, like what you're talking about. We say: oh, I'm going to restructure everything and make this thing profitable. Can you give us a sense? You have a sense of where Twitter is at in terms of profitability? Are they making money hand over fist? Or?

McKee: So, my understanding is there --- the main way they make money is through advertising, which is, kind of, pretty normal for, like, a social media tech firm. I don't think they make very much. I haven't. I did not. I should have looked up their annual statements and stuff before I came here, but I didn't. I think they might make a small profit, but it's certainly not anything close to the, you know, $44 billion that he's paying for the company. So, they're pretty close to, like, the pre-revenue stage that a lot of these tech companies have been in (or still are in) for many of them.

Stitzel: So, talk to us about those stages a little bit. What's a pre-revenue stage? And why is that important for tech?

McKee: I should have said, pre-income. They have revenue.

Stitzel: They have revenue, they just don't have positive net income.

McKee: But yeah. They don't have their own positive net income. Yeah. I mean, for those companies, you know --- companies like Google, Facebook, a lot of these social media inner tech kind of companies --- they started out, kind of, either not having any revenue at all, or they're just growing their service, or they had a small amount of revenue that did not nearly support their expenses. And their focus [was just] really heavily on just growing their sales [and] growing their all of their infrastructure to support eventually future profits. Something like Amazon --- [they] famously had very, very tight profit margins. I think they do make money, but it's not, like, a ton of money in terms of net income.

Stitzel: Not the type of money you think they would make.

McKee: That you would think based on their market capitalization. Yeah.

Stitzel: So, what's going on with tech companies that that seems to be the business model? Is it because the ways that they make money are, sort of, unpleasant to users of their services or?

McKee: Well, I mean, everyone hates advertising, right? I sure do. You probably did too, right? Yeah. I think a lot --- it's not just tech companies. Like, if you're a different kind of industry when you're first starting out, you're probably going to be doing a lot of trying to get a lot of growth. And you might not make profits right away. I mean, if anyone starts a business, [then] I'm sure they're not going to make profits from day one, unless they have a really good business model or something like that. So, and with --- I guess with a lot of the --- tech companies, they use software. So, it's not they don't have to build out as much as a, you know, like a manufacturing company would. And so, it's a lot easier to sell an additional unit of, you know, software or, you know, social media account to someone than it is to, you know, build a whole new car. Though, Musk is really good at building cars too apparently.

Stitzel: This is interesting, you know, because the marginal cost for tech services is pretty close to zero, right?

McKee: Yes.

Stitzel: It's not actually zero.

McKee: It’s not actually zero. But, yeah it's really close.

Stitzel: It's gonna be real close...

McKee: It's really small. Yes.

Stitzel:…as opposed to, like you said, building cars; which the marginal cost of it probably goes down, because you got fixed…

McKee: Yes.

Stitzel:…costs…

McKee: Yes.

Stitzel:…that are being spread out, but still pretty high relative to relative…

McKee: Yeah.

Stitzel:…to your total cost structure, right?

McKee: Yes. Yeah. A lot of the most successful, like, tech companies we've seen in the past 30 or 40 years now --- they've all pretty much all been software kind of focused. You know, Microsoft [and] Google does the Internet thing. They're all --- they don't tend to be the ones selling the computer hardware. There's a lot of companies that do that, but they don't have the kind of insane growth and hot, you know, attention from the press like some of the really famous tech companies.

Stitzel: So, I think if people started listing Amazon and Apple and Google and Facebook --- and Twitter's next. I mean, they're a big time player in this sphere. Where do they sit, like, size-wise [and] age where they're at in their business --- not business cycle [because] that's the economist in me, and they're in their --- sort of life cycle?

McKee: I mean, there are --- it's a younger company in the life cycle. Like, the FANG companies --- they all have pretty good profit profits by this point. And Twitter is, kind of, just barely starting to make a profit, or hasn't made a profit yet (at least not consistently). So, it's a --- I can't remember exactly when Twitter was…

Stitzel: I was trying to think of it.

McKee: I was trying to think of it too. Don't think of it either, but it's definitely younger than something like Apple. So, it's a little bit younger in the stage than those companies.

Stitzel: So, maybe all the tweeting by Elon Musk is just a very elaborate smoke screen, and he's just trying to buy a company out that's about to be profitable. Is that crazy?

McKee: I mean, no. So, profit motive. Yeah. This is --- I mean, we/I can't read his mind.

Stitzel: Of course.

McKee: He's very difficult to predict that for anyone, even if you are, you know, a lot smarter than [or] well connected than I am.

Stitzel: That's what makes him interesting, right, is he does very large expensive projects with electric cars and batteries and rockets and stuff. And you're looking at it going --- the profit motive doesn't seem to explain it. He's, kind of, got that crossover thing going between being a capitalist and being a philanthropist.

McKee: Hmm mmm.

Stitzel: It's like, but and yet, it seems like he's doing things that have the potential to change culture and society and technology. And so, I don't know [about] buying Twitter. Just seems like it fits in there. So, you don't…

McKee: Yeah.

Stitzel:…really think [that] oh it's got to be profit motive.

McKee: Yeah, I mean, he's (I think he's) talked in in his tweets about how he likes [and] wants free speech and values that. I tell my students, you know, when you own the company it's not just about maximizing profit. The owners they want to maximize their value. And I like to use a Chick-Fil-A example, because they shut their stores on Sunday. The owners value doing that even though it probably does not maximize their profits. So, yeah. If he values, you know, controlling and supporting free speech by making Twitter more friendly to that, I mean, [then] that's his money. It's a valid use of his money. And well, there's lots of billionaires who have, you know, purchased newspapers and platforms like that. And it's probably not because they're gonna expect to make a lot of money from that purchase. They probably lose money, to be honest, because newspapers are not a very, not a really great, business right now.

Stitzel: I talk about that in a similar way, right? Because, you know, sports teams have such an out-sized share of the, you know, the public's attention, relative to the size of industry.

McKee: Right.

Stitzel: It's very small, very small in industries, you know, relatively obscure. My favorite --- I heard this on (was it) a Michael Lewis or a Freakonomics Podcast episode. And they said the paper/the cardboard box industry is larger than the four major North American sports combined. Why is it people would own that? It's because they're toys, right?

McKee: Yeah.

Stitzel: Robert Craft doesn't own the Patriots.

McKee: Yeah.

Stitzel: It’s because he wants to make money. He wants to win a Super Bowl, and he wants to sit up in the suites and watch the games. I say, I don't see that so different here for Musk and Twitter. Let's talk a little bit about that, maybe the consequences of this; because you and I are chatting a little bit before we got started on this episode, and talking about Tesla stock, and what he's put up in personal equity and collaterals. So, I think I started us off saying he's putting up almost half, right? $21 billion?

McKee: Yes.

Stitzel: And personal equity. How's that tied to his Tesla ownership?

McKee: So, as far as we know with Musk --- most of his wealth is just from his shares of Tesla. So, he doesn't have a ton of cash. So, his financing for this deal, like you said, about half of it is coming from cash that presumably we think would be from him selling shares of Tesla (or shares he's previously sold). And then another portion of it is coming from debt that is being collateralized by Twitter's assets. And this is really common in a merger and acquisition. You'll basically borrow against the assets of the company you're acquiring. Kind of like if you're buying a car --- you borrow against the value of the car. You collateralize a mortgage by borrowing against the value of the house. You're just using the loan to buy. And then the last bit --- so, the other he's borrowing against the value of Tesla shares. So, it's basically a margin account on a much, much larger scale than a normal margin account. And so those are his main three sources of financing based on the summary we can see in the SEC filings.

Stitzel: Great. So, let's go through those one at a time. So, he's sold or is selling…

McKee: Or he's planning to. Yeah.

Stitzel:…Tesla stock. So, if he were --- I don't know what percentage owner he was, if he were ---- 100%, he'll be 90% owner after. And people come along they’ll want to buy Tesla.

McKee: Hmm mmm.

Stitzel: They buy Tesla. He's left with less of it. Pretty straightforward.

McKee: Yes.

Stitzel: Is that?

McKee: Yeah. He'd be selling. We think he'd be selling that. I mean, he could have other [means]. Maybe he already has the cash from options and things that he sold already.

Stitzel: But that's his purpose.

McKee: But the main source of his, you know, wealth right now is from Tesla going up so much. So, presumably it's coming from mostly Tesla.

Stitzel: And now, Tesla stock has gone down in recent days. What's going on there? Is that because he's selling it? Well it's always really tricky. It's always really dangerous to interpret that. Because, like, there's a lot of things that could happen. And I always --- I see articles all the time. Like, oh the market price of Tesla went down because of _____.  Actually well, it could be X, It could also be Y, X, A, B, C, D, E, F, [or] G. There's tons of things that could have happened. The theory is that, well, if Musk is spending time managing Twitter, [then] that's time he can't spend managing Tesla. You know, there's only 24 hours in the day. And, you know, time is a scarce resource here. Presumably, Musk is important for, you know, Tesla's value, because he is their Chief as a CEO for Tesla. So, that's the theory about why it dropped. I will also point out that the stock market itself went down a pretty large amount that day. And Tesla is a very volatile stock. So, you know, if tech stocks are down 2% on average --- I think NASDAQ was down about 2% that day --- and Tesla goes down 10% (you know, Tesla has a high beta), [then] most of it could have just been regular market movement. But…

Stitzel: Don’t read into it.  

McKee: So, you should always be really careful about those news articles. Like, well yeah. They say this could be the reason, but there's probably other things that affected it too; because the world's a real big place, and there's all sorts of new information coming in every single day.

Stitzel: I'm sure that's been said on my podcast before. But in economics, we actually have a rule that's never reason from a price change, right?

McKee: Hmm mmm.

Stitzel: Those are consequences, not causes. And so, you know, stock price --- not nothing invalid about that as a price.

McKee: Hmm mmm.

Stitzel: Same kind of philosophy there. You actually explained really well why we wouldn't…

McKee: Yeah.

Stitzel:…want to read into those kind of things.

McKee: So, there is some talk that I have seen that says: well, because the stock price is going down for Tesla, that might jeopardize his ability to finance the acquisition, because he's relying pretty heavily on his wealth from Tesla to provide that cash.

Stitzel: So, this is happenstance?

McKee: It could be happenstance. It could be because people are worried that he's going to do the acquisition. Of course, you then have, kind of, a chicken and the egg thing. Or it's like --- well, if he does do it, [then] Tesla price goes down. But if they think he does, it goes back up.

Stitzel: Yeah. So, that'll be something to watch.

McKee: So, yeah. Keeping an eye on both price of Tesla and Twitter [should] be kind of interesting, because they might, sort of, move; and, you know, they might be connected in how they move for over the next couple of months.

Stitzel: So, how would they move? Together maybe?

McKee: Possibly, yeah. Well, because Twitter stock --- so actually again right now Twitter's stock --- is significantly below the purchase price that the board and Musk have agreed to.

Stitzel: So I didn't check it today. Just, you know, when the offer came through he was offering it $54.20.

McKee: Yes.

Stitzel: When it was near $39.00. And I don't know what it's done.

McKee: So, it went up. It was it briefly hit $50.00. And then on Monday when --- and well actually Tuesday, because they made the deal announcement like right at the end of the market closing ---- it went down. So, it's about $40.00, sorry $49.00.

Stitzel: What? Why wouldn't it basically be bid up to that?

McKee: So, [in] a normal merger --- it would be, like, just a tiny bit below that offered price, because there's some risk it doesn't happen. But, and so the interpretation is --- well, there's a [belief that the] market doesn't think it's very likely to happen.

Stitzel: O.K., so if it's $49.00 and Musk is offering at $54.00, even though the board has agreed to accept the offer…

McKee: Yeah. It actually dropped when the board agreed. It dropped after the board agreed.

Stitzel: Why? That's so counter-intuitive.

McKee: Yeah. Again, I’m not.

Stitzel: Shouldn’t have the risk gone down?

McKee: I am confused by that. I think the risk went down. I actually, I'm not. This is not finance advice. Don't use it. Don't sue me. Like, I have --- I think it's more likely than --- I think it's very likely to actually happen. So, I took a personal position based on that spread. You know, I bought Twitter at $49.00. And I'm hoping I would then be able to sell it when the merger completes at $54.00. It's like a $5 profit. Yeah. So, I'll see how that works out.

Stitzel: So now I have to put a disclaimer in here,

McKee: But this is not investment advice.

Stitzel: EconBuff Podcast does not give…

McKee: Don’t sue me.

Stitzel:…professional investment advice. And you will not be held liable for it.

McKee: I did this last year too. I said I bought puts. That didn't work out too well. I hope this one works out better.

Stitzel: O.K., we'll check back in next time we have on the podcast to see how your track record is with Twitter. O.K., so then the next thing that he's doing is, would you say, collateralizing against the assets of the firm that he's buying --- Twitter?

McKee: Yes.

Stitzel: So, this is like --- if I stop paying on my house, [then] they come and repossess my house?

McKee: Yep.

Stitzel: So, if Musk doesn't come through, [then] they'll come repossess Twitter?

McKee: Yes. Yeah. Yeah. So, there's probably a big syndicate of banks. I think the filing lists a couple of them, but there's probably more that are involved too. And they basically extended a couple different loans to Elon, or more technically Elon's LLC, that's, you know, controlled by him. And the assets of Twitter are the collateral there. So, if he doesn't make his interest payments, then, you know, they're going to grab Twitter. Or they’ll go after Twitter at least. Yeah.

Stitzel: I'm trying to think of what the ramifications of that actually happening, given the way that we think about the people that own and run Twitter. But that, I guess they'd probably try to turn around and sell it? Or?

McKee: Yeah. I mean, banks aren't in the business of managing companies. They aren't in the business of, you know, renting out homes either. So, if they repossess your house, [then] they're going to turn around and try to sell it.

Stitzel: Yeah, and just recover them.

McKee: And try to recover their initial loan. Yes.

Stitzel: O.K., and then the last thing, the last way that he is financing it was what? I forgot.

McKee: It's a margin loan based on Tesla stock.

Stitzel: So, walk us walk us through that. That's nice.

McKee: So, it's like a margin account that you might have at a, just at a, brokerage, right? You are borrowing money from the broker, the bank, whatever. And here, he's basically putting up his stock as the collateral for that loan. So, instead of Twitter's assets --- it's Musk’s shares and Tesla. And then if, I mean if, it drops too much, [then] presumably we haven't seen the exact terms, but presumably he would have a margin call, essentially. He have to put up more shares or, you know, put in more cash and put up more collateral if Tesla’s stock dropped too much.

Stitzel: So, what's the downside of that? At some point, he can't bear that anymore and he ends up trying to get out of the deal?

McKee: Yeah.

Stitzel: What happens there? I mean, yeah. If it went down too much, and he just didn't have the cash, [then] like, he'd have to back out of the deal which would be really expensive for him. But [it would] not [be] as bad as, you know, the catastrophe of, you know, having all the banks charging in to, you know, to seize his assets from the, you know, from the loans; because he has to pay a $1 billion penalty if he backs out. And so does Twitter if they back out they have to pay $1 billion penalty to him.

Stitzel: This makes sense. This is like earnest money.

McKee: Kind of. Yeah.

Stitzel: Same kind of idea.

McKee: Yeah. And again, that's a very common clause you might see in a merger where, you know, if, either, you know, if they (if someone) back(s) out, [then] you know, they have to pay a penalty to the person that they were going to either acquire, or where the target has to pay a penalty.

Stitzel: And that was agreed upon at the time that the board?

McKee: Yeah. That's the --- that's part of the agreement that the board voted on to approve. Yes. So, this came out Monday night. So two days ago.

Stitzel: Do we have any sense of, you know, why the board would agree to accept this offer if their jobs are all on the line? You said earlier they're likely to all be replaced or fired or?

McKee: Yeah. So, typically board members get paid in some compensation with shares. So, they’re shareholders. I think Musk was making tweets about how they don't own very many shares. I mean, but again for your personal wealth, even if you don't own that many it might still be a pretty big payoff. So, there can be personal benefits. There's also things like a golden parachute where you basically payoff the CEO to make him leave peacefully without, you know, kind of, trashing the office as he exits.

Stitzel: Can you think any odds that they, you know, some individual board member just swears loyalty to Elon and then doesn't get replaced and becomes one of the subordinates?

McKee: I think I it would probably be good for Elon to have some continuity, because they have been on the board for a while, and they have more familiarity with the operations of Twitter and how it works. If he has to bring in all brand new people, [then] that could be something he needs to do --- because he just wants to get rid of them [or] because he thinks they're managing it poorly --- but they also have relevant experience that could be useful too.

Stitzel: So, he has to walk that line because…

McKee: He has to walk a line there…

Stitzel:…it's clear that he probably doesn't think they're running it super well.

McKee: Hmm mmm.

Stitzel: That’s not necessarily tied to their bottom line if we believe him without his comments…

McKee: Hmm mmm.

Stitzel:…about free speech, and, you know, making the source code open source, and stuff like that.

McKee: Yeah.

Stitzel: And those might be the changes that you make that aren't necessarily going to help the productivity. And he's also potentially got a big mess on his hands, if we really believe the people that are making noise, [that] they don’t want to work in a company for Elon Musk.

McKee: Oh yeah.

Stitzel: Like, they're some of their top lawyers I know have been pretty vocal about not wanting to.

McKee: And one ---- Musk might be happy that leave because then he doesn't have to deal with firing.

Stitzel: Right.

McKee: Because they're probably the people that are least in line with what he wants for the (what his vision for the) firm would be. But yeah. If there's lots of employees that just ditch after the acquisition, [then] that can cause issues too, because then the intellectual capital that those employees have is going to be a pretty large part of any business. And especially for a company like Twitter, where you're going to have a lot of, you know, programmers and employees that, you know, their entire value is based on intellectual capital that they're adding to the firm.

Stitzel: So, you've been very generous with your time. I kind of want to circle around…

McKee: Sure.

Stitzel:…one last thing here before we go. You actually mentioned this early on and this idea of activist investors. And I think that’s a theme…

McKee: Oh yeah.

Stitzel:…in this episode, because this isn't somebody we don’t --- I mean, we've theorized about this a little bit, but we don't ---- think this is necessarily a case where somebody looked at this and thought this company is being run terribly. I can buy it cheap. I can make these changes, question mark profit, right?

McKee: Yeah.

Stitzel: And kind of go that route. We think this is something else. And it does seem a lot like activism here. So, talk to us a little bit about activist investors, and, like, how they might enact some changes.

McKee: Yeah. So, the initial thing that Musk did before he made this acquisition offer was kind of the playbook --- that someone like Carl Ichan is kind of famous for this --- like how they would do it. So, Musk bought a bunch of shares. He bought 9.2%. He then was offered a seat on the board. So, that's usually the goal of an activist investor. Like, we buy up some shares and we try to get leverage with the board. Get seats on the board. Get them to, sort of, change their behavior. My assumption would be because Musk then after a couple days must [have] backed out [and] he said I don't want to be on the board, and then he made his offer. My assumption is Musk had some goals. He wants Twitter to change X, Y, and Z. And then he found out: like well, even if I’m on the board, can’t do it. I can't get them to change that. So, then he decided: well, I’ll just buy the whole company. But for someone like Ichan --- like, they'll buy up enough shares. They'll try to use those shares [and] then as leverage to get himself, or his, you know, his subordinates on the board --- a couple, one or two seats, three maybe, you know, [or] some minority seats. And that'll be enough to, kind of, enact leverage. Another, kind of, interesting thing that usually happens with these activist investors is, you know, Icahn will announce he has, you know, he's bought up 6%. He's over the threshold. He has to announce it. And then, you get what we often call a wolf pack, which is a whole bunch of other investors who will jump on forward with what Icahn is trying to do. And they'll vote with him. They will, you know, vote for his candidates. They'll advocate for the changes that he's trying to enact. But they're not, like, working for him. They're not explicitly colluding with him. So, they, you know, they don't trigger a poison pill in the thing, or, you know, there's no direct legal connection. But they're all --- they all, kind of, agree with him, and they're hoping to profit just like he is. So that happens a lot too. So, even though Icahn might have only 5% of the shares, there might be tons of other hedge funds [and] other investors who have jumped on board, and they're going to vote with him. So, he has a lot more shares voting with him than just the ones under his personal control.

Stitzel: So, how many? Do we have a sense of how many seats there are on the board of Twitter on the line? Are we talking like five? Are we talking like 12? 

McKee: I think they have something close to 10. I looked up like the names. I didn't count them.

Stitzel: Right.

McKee: But yeah. The size of the board can vary. Usually they'll have, you know, something relatively manageable like, you know, 5 to 12 or, you know, something in that range. They're not going to have hundreds of people. They're not going to have probably some anything smaller than like five or six people. That’s a really small board. And the exact size --- there's definitely research papers in our field that, like, look at the size and, like, how does that affect firm value. But I can't recall exactly, like, what those are.

Stitzel: Can’t really tell what those numbers are? Sure. Yeah. So, tell me about this individual. I’m not familiar. Icahn, you said?

McKee: Carl Icahn. Yeah. He's.

Stitzel: Yeah, so what would we know this individual from?

McKee: I mean, he's pretty much famous for doing this, kind of, activist investor thing where he's, you know, a billionaire investor. And he doesn't work like Warren Buffett. He kind of identifies companies that he thinks (are doing) are operating inefficiently. And he goes in and says: you should change. He --- a lot of times he doesn't buy the company. He just does the playbook where he buys a large stake, gets some influence with their board, and gets them to change it. You know, I think, so one example that I’m familiar with that was relatively recent [was] there's this petroleum company called Occidental. And they made a deal with Warren Buffett actually too. So, Warren Buffett helped them finance an acquisition of another oil company. And they gave Warren, you know, a pretty nice deal in terms of warrants and preferred stock --- that sort of thing. Icahn thought it was a terrible deal. He thought they, kind of, Warren Buffett sort of took him, you know, got him over a barrel, and then they made a bad decision by help in terms of that financing. So, he then bought up shares, tried to get them to change their paper. And I can't remember exactly how he (what he) wanted them to do. But that's one company that he, within the last couple years, has tried to, kind of, influence. He didn't buy a company entirely. He just bought enough shares that he could get some leverage.

Stitzel: So, I want to bring this episode in for a landing. You've been…

McKee: Sure.

Stitzel:…super generous with your time. So, parting question here. What kind of things do we commonly see activist investors do? You gave us one example there. We've got Musk maybe interested in free speech. What are activist investors targeting commonly?

McKee: One common thing is dividends. So, they might say: hey, you should be paying more in dividends. You don't have good investments. You should be paying out --- your payout ratio should be higher. That’s one thing I remember seeing a number of times with investors. Or another potential one might be, you know, this division you should just get rid of that division. Or you should spin off that division into its own company, or break up your company into like, three into multiple companies (like three companies or four companies), because you have this big conglomerate and you're not managing it well. But the individual pieces are going to be more valuable than the whole. They don't have to buy the company technically to do that. They could just get some leverage and convince the board that, yes, this will increase value for our shareholders. So those are some potential things they might be asking for if they, if you, have an activist investor.

Stitzel: My guest today has been Eric McKee. Eric, thanks for joining us on EconBuff.

McKee: Thank you for having me on.

Stitzel: Thank you for listening to this episode of the EconBuff. You can find all previous episodes on YouTube at EconBuff Podcast. You can check out our website at www.econbuffpodcast.wixsite.com. You can contact us at econbuffpodcast@yahoo.com.