If I jointly owned a business with another person, and the other person mortgaged his share of that business to buy into an unrelated venture that provided me with no benefit, I wouldn’t be happy about it. That’s exactly what Elon Musk is proposing to do, using his Tesla (NASDAQ:TSLA) shares as collateral for a loan to buy Twitter (TWTR).
Musk has offered $54.20/share for Twitter, which would put the value of the takeover at $43 billion including the 9.2% of shares that he already owns.
A commitment to funding for the transaction was posted last week on the EDGAR website. Elon Musk will provide equity financing and a group of banks led by Morgan Stanley will provide debt financing as follows:
- $6 billion in unsecured loans and $7 billion dollars in secured loans (secured by shares of the entity that will own Twitter) – to be repaid from future Twitter cash flow.
- A $12.5 billion margin loan secured by Elon Musk’s unencumbered Tesla shares
- Equity financing of $21 billion to be provided by Elon Musk
Musk is using some of his Tesla shares as collateral for the margin loan, but we don’t know anything about the origin of the $21 billion in cash. It is possible that Tesla shares are also being used as collateral for the equity component of the deal.
A possible source of Musk’s funds
Musk himself has often claimed to be “cash poor”, and it is generally accepted in the media that he does not have access to huge quantities of cash.
He does not take a salary from Tesla, except for minimum wage, and in the past, he has only sold Tesla shares in sufficient quantity to pay the taxes on the exercise of options. His second-largest asset is his ownership of SpaceX, but I think it is unlikely that he will sell any part of that to finance the Twitter purchase.
The commitment letter makes no mention of a partner for Musk’s cash injection, though that cannot be ruled out.
So that leaves Tesla shares as one possible source of cash. He is either intending to sell Tesla shares, or he has raised funds using his Tesla shares as collateral. It’s possible that he is using a loan agreement that is already in effect to provide the $21 billion.
In the last Proxy Statement (August 2021), Tesla stated that Musk’s share ownership “Includes 88,331,125 shares pledged as collateral to secure certain personal indebtedness”. If he is following Tesla’s policy of limiting his borrowing to 25% of the value of the shares, that would imply that he can borrow (or has borrowed) about $22 billion using already pledged Tesla stock as collateral.
This is speculation on my part, I obviously don’t have access to the details of his private finances, but the numbers tie in, and I present it as a possible scenario.
Total shares pledged
The terms of the proposed margin loan limit the initial loan amount to 20% of the value of the collateral. That means that for a $12.5 billion loan, Musk will have to pledge $62.5 billion worth of Tesla shares, or about 62.5 million shares at a price of $1,000 per share.
That would take his total shares pledged to 150.8 million out of a total of 170 million that he currently owns. That leaves him with very little wiggle room to raise money in the future without selling Tesla shares.
He also has approximately 80 million vested stock options, but they are restricted and cannot be used as collateral. The terms of his 2018 bonus plan place a 5-year hold period on the shares (except that he can sell enough shares to pay the strike price and any associated taxes).
Terms of the margin loan
The terms of the margin loan are important to understanding the risk for Tesla shareholders.
The loan is for a period of three years and bears an interest rate of “3-month term SOFR + 3%” (i.e. 4.78% currently), and a front-end fee of 0.5%.
Minimum payments are 5% per year ($625 million).
The initial loan to value ratio is 20%
The loan can be margin-called if the loan to value ratio reaches 35%, at which point Musk would have two days to come up with cash to reduce the loan to value ratio to the reset level of 25%. Pledging additional shares to increase the collateral is not permitted.
Assuming a starting value of $1,000 per share, the margin call comes at a share price of $571, at which point Musk would have to find $2.6 billion to lower the outstanding amount of the loan and bring the loan to value ratio down to the reset level. This could force the sale of some of Musk’s Tesla shares, putting downward pressure on the share price and lowering the collateral value further.
Full repayment of the loan is also mandatory if the VWAP of the shares falls below 40% of the share price at the Funding Date. Musk would have to find $12.5 billion to avoid default if Tesla’s share price falls below $400.
There is also the question of Tesla’s own policy which restricts loans to 25% of the value of the pledged shares and requires a cash injection to correct any shortfall. That would trigger a call for extra cash at a share price of $800.
The margin loan also includes a standard list of events that would trigger full repayment:
The last two are interesting:
“A judgement or order for the payment of money against the borrower” – Most readers do not have to be reminded that the verdict from the Solar City fraud trial is due any time now, and a trial in the “funding secured” suit is scheduled to start at the end of May. Either of those could result in a judgement for payment of money against Elon Musk.
“Any government investigation against the borrower that would reasonably be expected to have a Material Adverse Effect” – Musk seems to invite such an investigation with every action or Tweet.
Any of these events, followed by enforcement of the terms, would terminate the margin loan agreement, and the entire $12.5 billion would become immediately payable.
The risk for Tesla shareholders
Having such a large portion of the shares pledged as collateral presents a risk to Tesla shareholders for which there is no corresponding reward. Tesla gains nothing from Musk’s Twitter ownership except for another needless distraction for its CEO
Over an eight-week period in Q4 of last year, Musk sold about 11 million Tesla shares to pay the taxes from his option exercise. The sale negatively affected the share price which is still about 25% off the levels at which the shares were trading before that sale.
A forced sale triggered by the margin loan would almost certainly put downward pressure on Tesla’s share price. It is a risk to Tesla’s share price from an action that brings no benefit to Tesla’s shareholders.
With Tesla trading at around $1,000, the margin call price of $571 might seem a long way off. Even the $800 price that would trigger a cash injection to meet Tesla’s own policies might seem out of reach. But anyone who remembers the bursting of the dot.com bubble will tell you otherwise. Quality companies like Cisco and Microsoft were not immune to that bubble. Tesla shares are equally overvalued and won’t be immune to the bursting of the current bubble.
The last thing that Tesla shareholders need is a CEO hanging a millstone around their neck by using a large portion of his holdings to buy an unrelated company purely to satisfy his own ego.
There is no compelling reason to buy Tesla shares at current valuations, but investors should also be careful about “buying the dip”. If the share price should fall to the level where Elon Musk is forced to sell, the price could spiral out of control.