MoneyFitt

31 January 2023

Happy Tuesday… already the last day of January!

US large-cap S&P 500 closed 1.27% DOWN 🔻 Tech-heavy Nasdaq Composite closed 1.86% DOWN 🔻 Pan European STOXX Europe 600 closed 0.17% DOWN 🔻 HK’s Hang Seng Index closed 2.73% DOWN 🔻🔻Japan’s Nikkei 225 closed 0.19% UP ▲

📝 Focus

Twitter paying $300mn for debt used to take it over

📊 In the Markets

Adani bloodbath reaches US$70 billion

📖   MoneyFitt Explains

🎓 Leveraged Buyouts (LBOs)

📝 Focus

Twitter paying $300mn for debt used to take it over

Twitter Inc has made its first US$300 million quarterly interest payment on the US$12.5 billion of debt that Elon Musk raised to “take it private” last year, according to Bloomberg News. (Before the takeover, Twitter’s entire net debt only came to US$600 million.)

Twitter paid Morgan Stanley, Bank of America, Mitsubishi UFJ, Mizuho, Barclays, Societe Generale and BNP Paribas, the banks who funded the takeover but failed to sell on the debt to outside investors and got stuck with it.

You may wonder why, if Elon Musk borrowed all those billions to take over Twitter from public shareholders, why Twitter itself has to pay interest on that loan the company. And since Elon Musk sold US$22.9 billion in Tesla shares since last April, why hasn’t the debt gone down?

Unlike when we buy something on a credit card, Elon Musk didn’t personally (or along with investment partners) borrow from banks to buy the shares from Twitter shareholders at US$54.20 a share (a whole company valuation of US$44 billion, but a total cost including fees etc of US$46.5 billion.) Basically, it was what was known as a leveraged buyout 🎓, or “LBO”, in which the buyers create a company which usually includes a lot of debt as well as cash and then, effectively in one move, takes over and merges with the target company so that the debt used to take it over becomes the newly-restructured-target’s own debt. And that’s why Twitter is paying US$1.2 billion in annual interest on the debt that was used to take it over.

That debt came in the form (roughly) of US$6.5 billion worth of leveraged loans floating on rising overnight borrowing rates, $6bn in junk bonds, and a $500mn revolving credit line from the banks. When Musk agreed to buy Twitter in April, the bond market was already weak, with junk bonds in general at the time yielding 10.2% (with Musk’s reportedly yielding 11.75%), but after a series of sharp interest rate hikes by the Fed in 2022, they’re now yielding over 14%. 

The interest payment (coupon) from a bond is fixed, so when a bond price goes down, it means that the yield (coupon divided by bond price) goes up. 

So in Twitter’s case, the price of the junk bonds used to buy it has definitely plummetted (because of the market as a whole as well as Twitter/Musk reasons) reportedly by up to 40%, which means that (a.) the banks are nursing hundreds of millions in losses and (b.) it’s possible for Elon Musk to use his own Tesla-sale-financed cash to buy back the same junk bonds at a discount from his bankers.

📊 In the Markets

Markets fell sharply in the US on a big tech sell-off, as shares of Apple, Amazon and Google parent Alphabet, which are due to post results later this week, all slumped. They are among the 100+ S&P 500 companies due to report this week, which is also on Wednesday, when the US central bank (“The Fed” or Federal Reserve Bank) decides on interest rates.

The Fed raises interest rates to cool down an economy when inflation is too high (such as when overall prices rise by more than 2% in a year) and lowers it when economic growth is too low (particularly if unemployment is more than about 3% and 5%.) The Fed cares about both measures in what is known as its “dual mandate”, whereas many other independent central banks focus officially on controlling inflation.

The CME “FedWatch Tool” still lists the probability of an 0.25% hike at 98% as implied by futures prices traded on the exchange – meaning that it is not a forecast by economists or any other experts. It’s been above about 95% since the middle of the month.

Investors will be scrutinising and picking apart every word, cough and raised eyebrow from Fed Chair Jerome Powell’s news conference for whether the rate-hiking cycle may be coming to a close and for any hints about of how long rates could stay high… even though it’s been months of somewhat consistent signals from Fed officials that rates would stay “higher for longer” than the market is thinking. (Meanwhile, the BoE in London and the ECB in Frankfurt are widely expected to lift rates by 0.50% this week and hit their highest levels since 2008.)

Meanwhile, stocks in China rallied on the first trading day after the extended Chinese New Year holidays amid a rebound in consumption, though they cooled into the close. At the same time, Hong Kong’s benchmark Hang Seng Index saw a sharp correction, wiping out everything since it reopened last Thursday, with tech (Tencent, Alibaba) and casino (Wynn, Sands, MGM etc.) all tanking. Much chatter about cooperation between Alibaba founder Jack Ma and Thai billionaire Dhanin Chearavanont, aka Chia Kok Min, the boss of Thailand’s Charoen Pokphand conglomerate. And even more chatter about Alibaba (9988 in HK) moving its global HQ down to its new campus in Singapore, sending the stock down 7% on Monday even though the company denied the speculation several days ago and said its headquarters would remain in Hangzhou.

Adani bloodbath reaches US$70 billion 

The bloodbath continued on Monday. Under Hindenburg Research’s withering short seller attack (by revealing its position and publishing its reasoning publicly, rather than a brute force sale in the open market), Adani Group companies continued to plunge for a third consecutive day… despite the company’s angry 413-page rebuttal, including calling it a “calculated attack on India” and (a bit weirdly) calling Hindenburg the “Madoffs of Manhattan”. Hindenburg’s response to Adani’s response said it “ignores every key allegation” and “predictably tried to lead the focus away from substantive issues and instead stoked a nationalist narrative” while “failing to specifically answer” 62 of the 88 questions they’d raised.

A 5% recovery in flagship Ambani Enterprise’s share price wasn’t enough to prevent total losses since the release reaching almost US$70 billion as Adani Total Gas and Adani Green Energy both dropped by the 20% daily trading limit (meaning they could have dropped more), Adani Transmission fell more than 15% and Adani Power lost 5%. Adani Enterprises’ US$2.5 billion FPO (Follow-on Public Offer, a term used in India where a company that is already listed on a stock exchange issues new shares to new or existing shareholders) remains at risk, with only 3% of the proposed issue covered. However, Abu Dhabi conglomerate IHC (controlled by a key member of the emirate’s royal family) did commit to subscribing to US$400 million or 16% of the FPO. The stock closed on the NSE at ₹2,893, while the FPO price band is ₹3,112-3,276 a share. (One Indian Rupee, INR, Rs or ₹, is worth about 1.2 US cents. It’s fallen by about a third in the last decade.)

In case you’re keeping track, Gautam Adani is still richer than Mukesh Ambani, the chairman and managing director of Reliance Industries (India’s most valuable company by market capitalisation) but only just, according to Forbes, and split by Google’s Larry Page (and US$4.1 billion) in the real-time billionaires list.

Mini-explainer: Short-selling 

If you believe a stock will go down for whatever reason (perhaps it is expensive relative to its prospects or perhaps if you suspect fraud), you can sell the shares you have.But if you don’t own any of its shares, you can still sell them by first borrowing shares for a fee from an existing shareholder via your broker and then selling them on the market. (This can also be done through derivative instruments.)If you’re right, then you can buy them back (known as covering your shorts) at a lower price and pocket the difference, less the fee you paid to borrow the shares.

📖 MoneyFitt Explains

🎓  Leveraged Buyouts (LBOs)

In a leveraged buyout, LBO, buyers (investors and their bankers) form a new company to take over a target company. Often the amount of debt that the bankers put up in the form of bonds issued by the new company is many many times the amount of cash that investors put in (and as such may not be investment grade and have to pay a high yield, i.e. junk bonds). 

But what’s really interesting is that the bonds are issued against the combined assets of the buying and target companies, but of course, mainly the target. i.e. It’s NOT the buyer who is borrowing on their own account to buy the target! (The bonds are usually sold off by the underwriting investment bankers to third party investors.)

This is because after the buyout, the target becomes a subsidiary of the new company (or the two merge into one company) and all the target company’s debt and equity is effectively replaced by the new company’s debt and equity.

In a hostile takeover (unwilling target), an LBO can be an aggressive and effective tactic as 1) the target company’s assets are used as collateral for the bonds issued to take it over and 2) the target’s cash and cash flow is used to pay the resulting debt (and sometimes additional “management fees” to the buyer.)