Elon Musk’s deal to take over Twitter Inc.
private will nearly triple the social media company’s leverage and burden it with hundreds of millions of dollars in interest payable on the more than $25 billion used to fund the leveraged buyout.
Analysts estimate that Twitter’s interest expense will rise from $51 million in 2021 to $845 million per year. That’s more than half of the company’s adjusted annual profit of $1.4 billion in 2021, and the new debt would increase leverage to nearly nine times its adjusted annual profit. , against three and a half times currently.
Nine times earnings leverage would launch Twitter into the realm of tech and software-as-a-service buyouts, where the median leverage ratio was around 8.6 times earnings at the end of 2021 , but above the median for media companies, which is closer to about 7.5 times earnings, according to S&P Global Ratings.
Software vendors have generally justified borrowing high levels of debt with recurring revenue models that can increase profits without a concomitant increase in costs. However, Twitter’s business model currently resembles that of media companies, which depend on advertising revenue, a highly cyclical source of revenue tied to economic growth.
“The deal has been structured to have as much leverage as possible,” said Steven Hunter, managing director of 9fin, a leveraged financial research and data firm. “Even for a software buyout with seven rounds of leverage, you’d typically see a company with a much higher gross profit margin that is more cash-generating than Twitter.”
Twitter on Monday accepted Mr. Musk’s offer to take the company private. To fund his $44 billion bid, Mr. Musk secured $13 billion in loans from investment banks, including Morgan Stanley, Bank of America Corp., Barclays PLC and MUFG Bank Ltd., and a loan on $12.5 billion margin secured by a portion of its stake. at Tesla Inc.
Mr. Musk can pay the margin loan out of his own account, or Twitter can use company money to cover interest costs. Twitter and Mr. Musk did not immediately respond to requests for comment. Morgan Stanley, Bank of America and Barclays declined to comment. MUFG did not immediately respond to a request for comment.
Currently, Twitter has just over $5 billion in debt, mostly in the form of low-interest convertible bonds and unsecured debt, according to a recent offering memorandum. If shareholders agree to take Twitter private, the company will have to pay off all of its existing debt before that new debt is added to its books, analysts said. The company’s bond prices rose on news of Mr. Musk’s planned takeover to around 102 cents on the dollar.
Twitter generated $632 million in cash from operations in 2021 on the back of about $5 billion in revenue, according to the company’s annual report. Advertising contributes about 90% of the company’s revenue, while data licensing and other types of revenue make up the rest, according to Twitter’s latest annual earnings report.
Twitter has been working to grow its ad revenue under CEO Parag Agrawal, but it’s unclear if that vision will continue.
Mr. Musk has suggested that Twitter should rely less on advertisers and has so far not hinted at improving the product for them. Adding significant debt to Twitter’s books could make it difficult to scrap the current business model as Mr. Musk would have to rely on advertisers’ existing cash flow to cover interest payments, Colin Sebastian said. , senior research analyst at investment bank Robert. W. Baird & Co.
All of the debt financing planned to buy out Twitter is floating rate debt, which means that as benchmark interest rates rise, Twitter’s interest expense will also rise.
If U.S. interest rates were to rise one percentage point from current levels of around 0.25%, Twitter’s interest charges on its debt package could soar to $1 billion a year. said 9fin.
It is possible that Twitter will choose to replace approximately $6 billion of all debt, consisting of short-term bridge loans, with secured and unsecured bonds that would bear a fixed interest rate.
Still, all the extra debt should plunge Twitter deeper into junk rating. S&P Global Ratings, which currently rates Twitter at BB+ – or below investment grade – said on Tuesday it expects Twitter’s substantial increase in leverage to lead to a potential downgrade. several notches in the company’s credit rating. S&P has placed the company on negative watch and plans to dig deeper into the details of the margin loan.
Moody’s Investors Service also downgraded the company’s credit rating due to the expected increase in leverage. Fitch Ratings said it does not rate the social media company.
The structure of the deal could hamper Twitter’s ability to invest in technology and product development, analysts said.
“For any business that fits that mold…it’s not ideal to pour out a lot of your cash flow, or you might generate less cash flow to be able to invest in the platform because of those obligations” , said Mr. Sebastian. said.
—Katie Deighton contributed to this article.
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