It's difficult to remember an acquisition that has received more attention than the purchase of Twitter (NYSE:TWTR) by Tesla's Chief Executive Officer Elon Musk. There may not be one.
The deal's dramatic story began in early April when Musk surprisingly disclosed a 9% stake in the online platform. Since then, it has been perhaps the primary story in financial media. Indeed, the topic has become a political football, with politicians and pundits giving their takes on the site's value and the danger of passing it to private hands.
The roughly $44 billion acquisition has done more than just creating buzz. It propelled a strong bearish movement in Tesla (NASDAQ:TSLA) stock—which last month had a market capitalization above $1 trillion. It could even impact the 2024 presidential race, should Musk move (as appears likely) to reinstate former president Donald Trump's access to the platform.
There is an irony to all of the noise, however. The stock market has its voice—and it is saying, in no uncertain terms, that it's skeptical the deal will go through at all.
Understanding Merger Odds
Using a simple model, investors can roughly calculate what odds the market is placing on an acquisition going through. A simplistic example can provide some color.
Assume ABC Corporation trades at $70 when another company announces it will acquire ABC for $100 per share in cash. In this example, ABC stock almost always won't shoot straight up to $100—because there are risks.
In almost any case, the most notable is that the deal doesn't go through. The board of directors may reject the deal; many, in fact, believed that Twitter's board would not accept Musk's offer, though the board did so. Even if the board does accept, in some cases, shareholders can vote the deal down anyway.
Even if shareholders want the deal, antitrust authorities can get in the way. An excellent recent example is the proposed merger between NVIDIA (NASDAQ:NVDA) and Arm Holdings. The companies decided to end their agreement after the US Federal Trade Commission and other regulators challenged the tie-up.
Returning to our simplistic example, assume that on the $100 offer, ABC trades up to $95. At that price, we can calculate the odds the market is placing on the deal going through.
A merger that was guaranteed to go through would value ABC, right now, at $100. (We're ignoring the time value of money through to merger close; again, this is a simplistic example) If the deal doesn't go through, we can assume that ABC will fall back to its initial price of $70. As we shall see, this assumption isn't an exact fact, but in a simplistic calculation, it's our most precise estimate of value should the merger fail.
Our odds are equal to the difference between the original price and the current price (in this case, $95 less $70, or $25), divided by the difference between the original price and the offered compensation (in this case, $100 less $70, or $30). In this example, ABC at $95 is pricing in a roughly 83.3% chance ($25/$30) that the merger goes through.
Is $54.20 Guaranteed?
This simplistic model can provide a framework for understanding Twitter's merger odds—but only a framework. This situation has several moving parts.
Let's begin with the upside. Musk is offering $54.20 per share for the company in cash. But there's a catch. Over the weekend, Musk tweeted that the deal was "temporarily on hold" amid analysis of fake accounts on the site.
Putting a merger "temporarily on hold" isn't a thing. That has led to speculation that Musk is publicly posturing simply to renegotiate the deal at a lower price. These speculations gained force yesterday afternoon after the billionaire himself told the media a smaller offer is not "out of the question."
So an investor can't look at $54.20 as a guaranteed upside. It's at least possible that Musk plans to offer significantly less than that, threatening to walk away entirely if the Twitter board says no.
Legally, Musk isn't allowed to walk away. The common argument that Musk can pay the $1 billion breakup fee and move on is not valid. Musk agreed to buy the company barring a so-called Material Adverse Effect (MAE). No MAE has occurred. In theory, Twitter could sue Musk to force him to go through the agreed-to deal.
But practically, the board may not have the stomach for drawn-out conflict that could, in turn, impact the business. (Conservatives, in particular, might see the board's intransigence as further evidence of political bias.) So there is a world where Musk offers, say, $44.20—and Twitter accepts.
The Downside Risk
There's another reason the board might accept a lower price. Without a sale of some kind (and there are no apparent other bidders), Twitter stock falls sharply even from current levels.
Again, the simplistic model of understanding merger odds would suggest that TWTR stock, without Musk, would drop to its pre-offer price. But TWTR closed at $45.85 on Apr. 13. Somewhat incredibly, the stock is below its $39.31 close on Apr. 1, before Musk first announced his stake, an announcement that sent the stock up 27%.
Should Musk walk, Twitter does get $1 billion—but that's barely $1 per share after-tax. And there's no way the market values Twitter post-offer as it did pre-offer.
Most notably, tech stocks, including social media stocks, have fallen since Musk's offer on Apr. 14. Here's how the NASDAQ 100 index and the biggest social media stocks have performed since the close on Apr. 13:
- NASDAQ 100: -12.1%
- Twitter: -15.9%
- Meta Platforms: -6.6%
- Snap: -30.2%
- Pinterest: -5.2%
Meta Platforms (NASDAQ:FB) and Pinterest (NYSE:PINS) have held up, but FB stock already had plunged earlier this year, and Pinterest posted a strong earnings report in late April.
Twitter's first-quarter report, however, was mixed, with revenue growth below expectations. Meanwhile, privacy changes at Apple (NASDAQ:AAPL) have continued to pressure online advertising stocks of all kinds. The Trade Desk (NASDAQ:TTD), for instance, is down 22% over the last five weeks.
It seems likely that, in a world where Musk didn't take a stake and didn't make an offer, TWTR stock would trade below $30. Without Facebook's scale or Pinterest's strong earnings report, its trajectory would likely mirror that of tech more broadly, of Snap (NYSE:SNAP), and/or online ad plays like TTD. Given those sell-offs, a 25-30% sell-off in TWTR from its $39 close before Musk announced his involvement would not be a surprise. That would suggest a value for standalone Twitter in the range of $27 to $29.
Understanding The Odds
The estimates of upside and downside are just that: estimates. But from any view, the market is pricing in a reasonably low chance this deal will get done.
Assuming Musk won't renegotiate and that TWTR would drop to $28 if the deal fell through, the implied odds here, with TWTR at $38, are 38%. Put the upside at $49.20—a 50% probability Musk pays $54.20, and a 50% probability he pays $44.20—and the downside at $28, and we're still below 50%.
Investors can create their inputs to this model based on their belief of the odds of a lowered offer and the potential share price of a standalone Twitter.
But an investor has to stretch a bit to argue that the market is pricing in better than 50% odds of a Musk takeover. That argument has to assume that Musk is almost guaranteed to lower his offer below $45 or that Twitter stock on its own would be worth $25 or less.
Indeed, neither argument is ridiculous. But even with aggressive assumptions (say, a revised offer at $42 and downside at $24), the odds of a deal getting done still sit around 75%.
All told, the market is pricing in significant skepticism toward this deal. Investors who believe that Musk will indeed come through should take a long look at owning Twitter at $38—but they should also understand that owning this stock, at this point, is a contrarian trade.
As of this writing, Vince Martin has no positions in any securities mentioned.
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