Tesla (NASDAQ:TSLA) stock got rocked this week after CEO Elon Musk revealed he had sold $3.95 billion of his Tesla stake. Many analysts immediately drew lines from the rapid-fire disposal to Twitter’s recent stumbles. It only took the world’s richest man three months to renege on his promise to avoid “emergency” sales of TSLA stock.
At first glance, Twitter’s influence over Musk’s actions seems odd. Why would a man worth $200 billion… who owns a company worth over $600 billion… worry about a venture that supposedly loses only $4 million per day? To an average person with $200,000 saved up (or one-millionth of an Elon), that comes to $4 in daily spending.
But like a good Shakespearian plot, the fortunes of Twitter and Tesla are now inextricably linked. And as Musk takes increasingly drastic moves to shore up the social media platform’s fortunes, it’s becoming clear:
As Twitter’s troubles multiply, so too does the risk of a Tesla stock crash.
Why Elon Musk’s Twitter Saga Could Cost Tesla Dearly
Like any epic drama, the Twitter-Tesla story comes in three acts.
1. The Setup: The Twitter LBO
To finance the fourth-largest leveraged buyout (LBO) in history, Elon Musk needed to come up with around $42 billion in cash to pay for Twitter’s shares that he didn’t already own.
There was, however, a slight problem. Elon Musk’s $200 billion fortune is tied up in Tesla, SpaceX and Boring Company stock.
According to Bloomberg’s Billionaire Index, Musk only had around $17.8 billion in cash available at the time of Twitter’s closing, which included $6.9 billion from a recent TSLA stock share sale.
That presented a simple mathematical problem. Assuming Bloomberg’s assumptions are correct, Musk still needed over $24 billion to complete the deal. (More later on why he didn’t simply sell TSLA stock to make up the entire difference).
For $7.1 billion, Musk turned to a consortium of equity investors, including $1.9 billion from Saudi Prince Alwaleed bin Talal Al Saud and $700 million from Dubai-based VyCapital. These investments are now the target of a potential Committee on Foreign Investment in the United States (CFIUS) investigation. In addition, another $13 billion was financed with loans from a consortium of banks led by Morgan Stanley (NYSE:MS).
That left $4.6 billion to be financed. And that’s where Tesla comes in.
2. The Mystery: How Tesla Got Involved
To magic up $4.6 billion, Elon Musk would have turned to his Tesla shares as a source of collateral. According to the electric vehicle (EV) maker’s latest proxy document, Musk has pledged around half his stake — 268 million shares — of which he can raise up to 25% of their market value as loans (or about $10.3 billion at current prices). It’s an easy source of liquidity in good times and plugs his funding gap with plenty of breathing room. Bloomberg’s Billionaire Index also agrees on $4.6 billion as the value of currently pledged Tesla shares.
But as options investors all know, a portfolio’s market value is a tentative security at best. Today, every 10% decline in TSLA stock means over $1 billion of liquidity gets wiped off Musk’s credit facility. An additional $6.4 billion liability with pledged SpaceX shares adds to that risk. If the value of Musk’s holdings drop, so too does his ability to keep Twitter’s financing afloat.
These problems are compounded by the terms of Twitter’s $13 billion of bank financing, which came with change-of-control protections. Under their terms, Elon Musk cannot sell his majority stake without potentially triggering a clause that forces Twitter to offer repurchasing all notes at 101% face value — a ruinous amount that would immediately sink the firm. The debt also limits Musk’s ability to raise additional secured capital; future rounds will involve unsecured junk bonds with strict financial covenants. In other words, Elon Musk can’t walk away from Twitter unless he deals with the $13 billion debt pile first.
3. The Catch: Why Tesla Stock Is Now at Risk
Finally, that brings us to the risks to Tesla’s valuation.
Currently, Tesla’s voting rules require a two-thirds majority for any corporate measure to pass, rather than the regular 50%. That gives Musk’s 25% stake an outsized say. To override his block of votes, almost 90% of external shareholders must oppose him — a hurdle that has proved too high in the past to contest the CEO’s unusually generous compensation packages.
The supermajority vote is fragile, however. In 2019, 99% of outside investors voted in favor of removing the threshold; the vote only failed because too few investors took part in the referendum. And for every 1% stake Musk sells today, the number of investors who must oppose him (or abstain) is reduced by 1.2%. Sell too many TSLA shares and Musk risks losing control of his crown jewel, just as rivals are catching up.
This would have ruinous effects on Tesla’s premium valuation. TSLA stock currently trade at around 33 times 2024 earnings and 22 times 2024 EV/EBITDA — a factor often ascribed to the company’s “eccentric, meme-loving mogul” that has “inspired legions of loyal Tesla evangelists and investors.” Musk’s friendly relationship with the Chinese government has also helped his EV firm generate unusually large profits from that country.
Lose those factors and Tesla’s shares are worth closer to $120, according to a 3-stage DCF (discounted cash flow) model.
Markets already seem keenly aware of these risks. News at Twitter seems to magically appear on the TSLA stock chart. As problems pile up at the social media platform, the trend will only strengthen.
In for a Penny, In for a Pound
Elon Musk’s problems are compounded by Twitter’s growing liabilities.
His social media firm now consumes around $1 billion in interest payments, $853 million in cash burn (assuming trailing 12-month rates) and could potentially lose another $1.6 billion if ad revenues decline by 30% as advertisers flee the platform. All told, Elon’s $4.6 billion debt adventure could grow by $3.5 billion or more per year — a rate that would force the business magnate to sell an additional 4 million Tesla shares per quarter.
Twitter is also becoming a legal risk. This week, both Chief Information Security Officer Lea Kissner and Chief Compliance Officer Marianne Fogarty resigned from the embattled firm just as Federal Trade Commission (FTC) compliance notices are coming due. The firm now risks billions in fines if it “so much as sneezes” without doing a privacy review beforehand.
“I anticipate that all of you will be pressured by management into pushing out changes that will likely lead to major incidents,” a Twitter lawyer wrote in an internal message, as reported by The Verge.
That means the tail ($44 billion Twitter) is now wagging the dog ($600 billion Tesla). Elon Musk’s problem isn’t a $4 million daily cash burn rate. It’s $13 billion in bonds, $3.5 billion in potential annual Twitter cash burn, potential billions in legal fines and no easy way out.
The Finale: Could Twitter and Tesla Still Win?
Elon Musk has surprised doubters in the past. Writers at The Economist note:
“His critics have to accept that the my-way-or-the-highway approach has worked before […] At his other firms, like Tesla and SpaceX, Mr Musk may not have offered empathy but has provided a planet-sized sense of purpose, from popularising electric vehicles to colonising Mars.”
Musk’s hard-handed approach to reforming Twitter could still work. MBA professors have also long-touted the benefits of having strong leaders, particularly those who are catalysts to change. Musk crudely ticks those boxes, no matter how unconventional his management style may seem.
That means the world’s richest man could still turn Twitter around. The social media firm largely stagnated under its previous management and could use a punch in the arm. Musk’s wealth also still covers Twitter’s debt burden at least 10 times over.
Musk also has equity stakes in SpaceX and the Boring Company worth around $43 billion. Though it’s an unattractive option, he could potentially sell these assets to raise cash to keep his Tesla stake intact.
But Musk’s strategy still comes with big risks. Studies by U.S. research firm Strategic Vision found that 39% of car buyers now say they wouldn’t consider a Tesla. That’s a product of Musk’s divisive approach. Recently, researchers at MIT also concluded that Twitter may have lost more than 1 million users since Elon Musk took over. The social media platform has since released opposing figures.
The future of Twitter is still to be written. Its drama, though, is already sinking TSLA stock.
On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.