12/5/2022 | Business Insider
Elon Musk gambled big on Twitter. Tesla is going to pay the price
Whatever you might think of Twitter, it's hard to watch Elon Musk clumsily flay it alive to "save it."
Twitter was far from perfect before Musk took over, but it wasn't in financial distress. Revenue growth was healthy but slowing, and management had been looking at head-count reductions to restore skinny profits while it pushed for ways to boost sales. Normal stuff.
That changed overnight when Musk took over. He dismissed Twitter's top management and its board of directors. Most of Twitter's employees and contractors have been fired or quit after rejecting Musk's "hardcore" ultimatum. The skeleton crew still employed is struggling to keep Twitter's already creaky infrastructure from breaking. Worse, an alarming number of advertisers are leaving Twitter after a spike in hate speech and misinformation on the site. Meanwhile, Musk's ad hoc ideas for boosting revenue have already backfired or were previously considered too risky. And all of these business troubles come after Musk burned Twitter's cash cushion during his acquisition.
I've analyzed how companies get into and then out of financial distress for more than 20 years, and I've never seen new management blow up a company as fast as Musk is destroying Twitter.
So now the question becomes: How does Musk keep his new purchase afloat? Having observed Musk in action for years there is one troubling option I suspect he may pursue: raid Tesla. But siphoning cash from Tesla, Musk's only profitable company, just as serious competition is toppling its dominance, should concern Tesla's investors. And given his obsession with Twitter, they may well ask: How far will Elon go to save Twitter at Tesla's expense?
How Musk could use Tesla to try and save Twitter
Musk cobbled together his Twitter funding primarily by selling off a major chunk of his stock in Tesla and taking out huge loans. This strategy has left the social-media company with little, if any, cash cushion to fund its recovery. Twitter used the $42 billion collected from the deal to buy back and retire its stock and whatever was left of the $6 billion in cash it reported at the end of June was used to retire the company's $5.29 billion in existing bonds. Tack on the $13 billion in pricey new debt and the roughly $1.29 billion in annual interest costs that Musk's leveraged buyout saddled the company with, and Twitter is running deep in the red as its cash circles the drain.
Between paying severance to thousands of fired employees and hiring new ones, plus rising costs for collateral damage Musk is creating, Twitter will likely consume considerable cash for a while as it tries to rebound — all while trying to stop the alarming exodus of vital advertising revenue Musk is fueling. Unfortunately, Musk has burned bridges with the logical parties that could backstop Twitter's growing liquidity pressure. Musk's bankers, for example, are unlikely to be interested in loaning Twitter more cash. They are already facing losses of more than $500 million on the loans they arranged back in April, after spiking interest rates and Twitter's deteriorating financial prospects under Musk killed the market appeal on the proposed bonds arranged to fund the deal.
And with Twitter's LBO debt valued at just 50 to 60 cents on the dollar, the investors who contributed cash to help Elon buy Twitter might have already had their equity value wiped out. That's very bad news for Musk's fellow equity owners who, he even admitted, "obviously" paid too much in the first place. They have little recourse since, as they should have expected going in, Musk owns the lion's share of the company and has fired everyone with significant authority to challenge him.
Musk, of course, could sell off more of his valuable stake in Tesla to continue funding the company. He did recently sell another $4 billion worth of shares, which he claimed was to help save Twitter. This may be true, but this amount also corresponds with the hit I have calculated he likely took with his personal margin loans as Tesla's stock plunged 49% since the company's latest proxy filing on March 31. That leaves Musk, who paid $44 billion for the most expensive impulse buy ever, with fewer options to keep Twitter afloat. Given his track record, there's a good chance he'll fall back on Tesla, his richest company.
This would repeat an old pattern for Musk. He has previously used his various companies to support new or adjacent ventures, often with little visibility into how the money is flowing. When Tesla was struggling in 2009, Musk borrowed $20 million from SpaceX to keep the carmaker afloat. SolarCity, the solar-panel company founded by two of Musk's cousins, in which he had a sizable stake, also received significant support from Musk's firms before Tesla finally stepped in to buy the nearly-bankrupt company in 2016, absorbing its roughly $3 billion in debt. And in 2018, SpaceX investors raised the alarm after funds were used to support Musk's tunnel-transportation venture, The Boring Company. SpaceX was eventually given a 6% stake in the Boring Company in exchange. To this day, Musk's various companies routinely do business with each other. It's all in the family — a family Musk completely controls.
As I've written before, Musk may try something similar with Twitter. He has already floated the idea of "X, the everything app," which Musk has suggested would combine social media, payments, news, food ordering, and more. He also created "X Holdings" — a holding company that he used to buy Twitter — which he has suggested could be used to house all of his various companies. So under the guise of synergies between Tesla — particularly the AI technology behind its controversial Autopilot systems — and Musk's vision for this all-encompassing app, he could direct Tesla to "invest" in Twitter to get access to potentially billions of its cash and resources.
If this happened, Tesla investors may or may not know how much it supports Twitter. Unlike Tesla's 2016 takeover of SolarCity, which was done with reasonable transparency, Tesla set up its Shanghai operations in 2019 as an unrestricted subsidiary with very limited visibility. Because of this arrangement, Tesla's investors only get a piecemeal snapshot of the China business' contributions to the overall company. Tesla has been able to use this obscurity to mask the fact that its China operations generate most if not all the company's total profits and cash flow while contributing less than 30% of total revenue — implying Tesla's US operations are still largely unprofitable after 18 years.
Tesla could create a similar special purpose entity, or SPE, for example, to invest in Twitter, but this time to help shield Twitter's struggling operations and failing financial condition, as well as its drain on the parent company, from investors. After all, tracing Tesla's cash is already tricky. Roughly a third of Tesla's $20 billion in cash (as of September 30) is held overseas, mostly in China, where it stays. Most of the remaining balance can be traced to more than $12 billion raised from selling stock in it since 2020, plus nearly $4.7 billion collected from energy-credit subsidies. Tesla's operations have only begun to generate significant cash over the past year — though much of that, by my estimate, comes from subsidies and creative accounting adjustments like paying salaries and bonuses in stock instead of cash.
While siphoning money to support Twitter is a controversial strategy, it wouldn't significantly impair Tesla's financial condition — at least in the short term. At present, Tesla has very little debt and the company recently netted an investment grade credit quality rating from S&P Global. The company's debt-to-EBITDA ratio, an indication of how well cash earnings may support a company's debt, and a key measure of financial stability — is just 0.4x based on my 2022 estimate for $18.7 billion in EBITDA. Musk could direct Tesla to borrow as much as $10 billion to $20 billion, for example, and still only increase that ratio to 0.9x or 1.4x, respectively. That's still well within investment-grade rating limits. Tesla's situation could worsen, of course. But even if Tesla's EBITDA plunged by half after adding as much as $20 billion in debt, the indicated leverage ratio would still be less than 3x , near the high range for investment-grade credit quality but still comfortably manageable.
The trouble is, Tesla's future prosperity has become less certain. If Tesla's operations continue to struggle to sustain profits and cash flow because of deteriorating business conditions, as I suspect, its healthy cash cushion could start to shrink just as Elon starts draining cash to save Twitter.
Tesla is facing a tougher road ahead
Elon Musk has been celebrated as the richest man on the planet mostly by making Tesla the most valuable carmaker ever. But this happened despite Musk being a famously bad manager and a worse boss, as I and many others have observed for years.
What gets lost in the legends of Musk and Tesla is how much he benefited from lots of help and fortuitous timing on his road to success. Tesla was remarkably indulged for the 18 long years it took to finally generate a profit, thanks to billions of dollars in tax breaks and energy-credit subsidies, lax regulatory oversight, an obedient board, favorable lending terms, and an always welcoming stock market. These advantages at home, landmark support for electric-vehicle-market development in Europe and China, and a lack of real competition kept Tesla afloat as it clawed its way to viability.
But that good fortune is running dry. Years of starving research and development while cutting corners in manufacturing have left Tesla with a sparse and aging fleet that persistently ranks near the bottom in quality and reliability. Meanwhile, Tesla's toughest competitors have rolled out scores of new models, and dozens more will come to market before Tesla's next entry — whatever that is. And nothing in its meager and perpetually delayed pipeline, from the quirky Cybertruck to the Semi Truck, seems likely to move the needle sufficiently, if at all, to change its prospects. No wonder Tesla has been losing share in every major market.
Tesla's predicament reminds me of BlackBerry, which also was the darling in a new market for years — until it wasn't. BlackBerry failed to sustain investment in new product innovation and ignored burgeoning market trends until its competition surpassed it. BlackBerry never regained its former glory.
With no new models, and its last market expansions of its last model, Model Y, starting to lap, I expect Tesla's incremental delivery growth will run its course this year — especially in China, where I have calculated Tesla still makes most, if not all, of its profits. If so, Tesla's slowing revenue growth and shrinking margins would disappoint investors' expectations for continued explosive growth. Sure enough, Tesla has trailed market expectations so far this year — especially in the third quarter. Ground zero for disappointing sales has been in China, where Tesla's deliveries have fallen short despite lowering prices and increasing incentives. In a market where Elon used to brag that Tesla would need several plants just to meet local demand, it can't sell the cars it produces from one.
Tesla's nearly $600 billion market share is still two to three times the value of its largest competitors combined, despite contributing only 2% to 3% of global sales. With its dominance in EV markets shrinking compared to aggressive competitors already outpacing its dated models, it's clear Tesla has room to fall further.
Tesla's diminished prospects have been hard on its stock, already under pressure due to the expectation that Elon would be forced to sell more of his stake to close the Twitter sale and concerns over his divided attention. Tesla's stock is down more than 50% this year — evaporating nearly $700 billion in market-cap value since its peak in late 2021.
We'll know soon enough if Tesla's currently healthy financial condition follows the deterioration in its stock. Saving Twitter won't kill Tesla anytime soon, and Twitter might not survive unless it does, but Musk is draining Tesla's capacity to weather what could be its toughest challenges ahead.