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For those with a steel-lined stomach, an exciting merger arbitrage opportunity has opened up in the case of Elon Musk's bid to acquire Twitter Inc. (NYSE:TWTR).
Musk, who is reputed to be the world's richest person and controls iconic companies like Tesla (TSLA) and SpaceX, began his campaign to acquire the social network company on April 4. At that time, he revealed he had acquired 9% of Twitter's stock. After some back and forth with the company about joining the board of directors, he backed out and announced his intention to take over the entire company.
On April 25, Twitter announced it had agreed to sell itself to Elon Musk for $54.20 per share. Musk filed documents detailing the committed financing put in place to fund the acquisition provided by a consortium of banks and composed of a senior secured bank facility, secured and unsecured bonds, a master loan facility (using Musk's Tesla stock as collateral) and an equity contribution.
Twitter is a global platform for public self-expression and conversation in real time and the preferred platform for many celebrities to engage with their followers. Musk himself is a prolific user of Twitter, and so this takeover may be a bit of a hobby horse for the world's richest man. He has often opined that he is not happy with Twitter's "editorial policies," i.e. the fact that his tweets are subject to certain SEC regulations due to their ability to move markets as well as Twitter's efforts to moderate its platform (Musk is a self-proclaimed free speech "absolutist").
Currently the gap between the deal price of $54.50 and the stock price of around $41 is very wide. Twitter stock and Elon Musk are widely followed by retail investors, and it is possible that there is a lot of excitement and speculative activity around the stock which adds to volatility. Recently, one of Elon Musk's tweets set the stock plunging, thus opening up an arbitrage opportunity.
Musk said in his tweet that the "Twitter deal [is] temporarily on hold pending details supporting calculation that spam/fake accounts do indeed represent less than 5% of users." Musk's tweet referred to a Reuters dispatch from May 2 that cited Twitter's 10-Q filing in which the company disclosed the issue of fake accounts and their responsibility for fewer than 5% of Twitter's monetizable daily active users [mDAUs]. He added unreassuringly in a follow-up tweet that he is still committed to the deal. There is of course speculation that Musk is angling for a discount on the buyout price and will not completely renege on the deal, but the fear that Musk is suffering from buyer's remorse is gripping investors.
As I write this, there is a 32% difference between the deal price and the stock price (assuming the deal closes as agreed). The company originally anticipated the deal closing in 2022. While the deal remains in place for now, there is a high risk owing to Musk's mercurial nature as well as the political implications of social media platforms, which may prevent smooth approvals from various governments around the world.
Nevertheless, the company appears to be undervalued. The GuruFocus Value chart puts Twitter as significantly undervalued.
Twitter is an unmatched and irreplaceable global communication megaphone. Morningstar's fair value estimate (before Musk's investment) put Twitter's fair value at $58 per share. So even if the deal were to fail, I believe Twitter's fundamental value is quite good and well above the current price. If Musk or Twitter backs out of the deal without good legal reasons which will hold up in a court of law, a brutal legal battle is sure to ensue, and there is a breakup fee of $1 billion.
There is a high possibility that other companies or investment groups might want to grab Twitter if the deal fails. For example, the Saudi Arabian billionaire Prince Alwaleed bin Talal, who is the second biggest non-institutional shareholder (after Musk) of the micro-blogging site through his firm Kingdom Holding Company, is unhappy with the SpaceX and Teslas CEO attempt to acquire the company.
So overall, for risk-tolerant investors, I believe this could be a great arbitrage opportunity, and even if the deal fails, it's still undervalued. Twitter stock at $41 is not too far from the pre-deal price of $38, before the drama started. Twitter is a very valuable company, which puts a floor under the stock, while the upside potential is quite good at over 30% presently.
This article first appeared on GuruFocus.