If I jointly owned a business with another person and the other person mortgaged their share of that business to buy an unrelated business that brought me no benefit, I would not be happy to this. This is exactly what Elon Musk is proposing, 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 takeover’s value at $43 billion, including the 9.2% share he already owns.
A commitment to fund the transaction was posted last week on EDGAR’s 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 in secured loans (secured by shares of the entity that will own Twitter) – to be repaid from Twitter’s future cash flows.
- $12.5 billion margin loan secured by Elon Musk’s unencumbered Tesla shares
- Equity financing of $21 billion will be provided by Elon Musk
Musk is using some of his Tesla stock as collateral for the margin loan, but we don’t know where the $21 billion in cash came from. It is possible that Tesla shares will also be used as collateral for the equity component of the deal.
A possible source of Musk’s funds
Musk himself has often claimed to be “money poor”, and it is generally accepted in the media that he does not have access to huge amounts of money.
He takes no salary from Tesla except minimum wage, and in the past he has only sold enough Tesla stock to pay taxes on exercising options. His second most important asset is his ownership of SpaceX, but I think he’s unlikely to sell any of it to fund the purchase of Twitter.
The engagement letter makes no mention of a partner for Musk’s cash injection, although that cannot be ruled out.
So that leaves Tesla shares as a possible source of cash. Either he intends to sell Tesla stock or he has raised funds using his Tesla stock as collateral. It is possible that he will use a loan agreement that is already in place to provide the $21 billion.
In the most recent proxy statement (August 2021), Tesla stated that Musk’s shareholding “Includes 88,331,125 shares pledged to secure certain personal debts”. If he follows Tesla’s policy of limiting borrowing to 25% of stock value, that would imply that he can borrow (or has borrowed) about $22 billion using Tesla shares already pledged as collateral. .
This is speculation on my part, I obviously don’t have access to the details of his private finances, but the numbers match, 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. This means that for a $12.5 billion loan, Musk will have to pledge $62.5 billion of Tesla stock, or about 62.5 million shares at a price of $1,000 per share.
This would bring his total pledged shares to 150.8 million out of a total of 170 million he currently owns. This leaves him with very little leeway to raise funds in the future without selling Tesla shares.
He also has around 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 associated taxes).
Margin Loan Terms
The terms of the margin loan are important in understanding the risk to Tesla shareholders.
The loan is for three years and bears interest at “SOFR 3 months + 3%” (ie 4.78% currently), and an entry fee of 0.5%.
Minimum payments are 5% per year ($625 million).
Initial LTV is 20%
The loan can be called on margin if the LTV reaches 35%, in which case Musk would have two days to find cash to reduce the LTV to the reset level of 25%. The pledging of additional shares to increase the security is not permitted.
Assuming a starting value of $1,000 per share, the margin call is offered at a share price of $571, in which case Musk would need to find $2.6 billion to reduce the loan outstanding and bring the loan-to-value ratio back to the reset level. This could force the sale of some of Musk’s Tesla shares, putting downward pressure on the stock price and further lowering the value of the collateral.
Full repayment of the loan is also mandatory if the VWAP of the shares falls below 40% of the share price on the funding date. Musk would have to come up with $12.5 billion to avoid default if Tesla’s stock price falls below $400.
There is also the matter of Tesla’s own policy which limits loans to 25% of the value of the pledged shares and requires a cash injection to correct any shortfall. This would trigger a call for additional cash at a share price of $800.
Margin lending also includes a standard list of events that would trigger a full refund:
The last two are interesting:
“A judgment or order to pay money against the borrower– It is needless to remind most readers that the verdict in the Solar City fraud lawsuit is expected at any time, and a trial in the “secured funding” lawsuit is expected to begin in late May. either of these could result in a judgment for payment of money against Elon Musk.
“Any government investigation against the borrower that could reasonably be expected to have a material adverse effect– Musk seems to invite such inquiry with every action or Tweet.
Any of these events, followed by the fulfillment of the conditions, would terminate the margin loan agreement and the full $12.5 billion would become immediately due and payable.
The risk for Tesla shareholders
Having so much of the stock pledged presents a risk to Tesla shareholders for which there is no corresponding reward. Tesla earns nothing from Musk’s Twitter ownership, except for another unnecessary distraction for its CEO
Over an eight-week period in the fourth quarter of last year, Musk sold about 11 million Tesla shares to pay taxes from his option exercise. The sale had a negative impact on the stock price, which is still around 25% below the levels at which the shares were trading before this sale.
A forced sale triggered by the margin loan would almost certainly put downward pressure on Tesla’s stock price. It is a risk to Tesla’s share price of a stock that provides no benefit to Tesla shareholders.
With Tesla trading at around $1,000, the margin call price of $571 may seem far off. Even the $800 price tag that would trigger a cash injection to meet Tesla’s own policies might seem out of reach. But anyone who remembers the dot.com bubble burst will tell you otherwise. Quality companies like Cisco and Microsoft were not immune to this bubble. Tesla shares are also overvalued and will not be immune to the bursting of the current bubble.
The last thing Tesla shareholders need is a CEO hanging a grindstone around their necks by using a large portion of his holdings to buy an unrelated company just to satisfy his own ego.
There’s no compelling reason to buy Tesla shares at current valuations, but investors should also be careful of “buying the dip.” If the stock price were to fall to the level where Elon Musk is forced to sell, the price could spin out of control.