Macaskill on markets: Begging for scraps at the court of King Elon is a risky business

Morgan Stanley seems to have scored a fee-generating coup from its role as lead adviser to Elon Musk’s purchase of Twitter. The swift capitulation by Twitter’s board and large shareholders to the takeover offer could lead to advisory and financing fee payments at a faster pace than banks can normally expect from a leveraged buyout.

The narrative of the deal’s progression has already been presented in terms familiar to anyone with memories of Wall Street takeovers in the 1980s: the visionary buyer (Musk) makes an unwelcome offer for a struggling public company (Twitter); bankers race to put together a financing package to fund a deal to take the company private, including details that seem heroic to Wall Street insiders, such as weekend phone calls to chief executives, sometimes interrupting family gatherings; and helicopter rides can be added as required.

Morgan Stanley delivered an assured performance in its lead role for the Twitter deal.

A $25.5 billion financing package, including a combination of debt and margin loans backed by Musk’s Tesla holdings, was quickly arranged by Morgan Stanley advisers. Calls were made during the Easter weekend to make sure that senior executives at other banks would join the deal. Helicopters may or may not have been involved, but it was clearly an adrenaline-filled few days for the bankers.

Twitter’s own advisers – Goldman Sachs, JPMorgan and Allen & Company – also played their role in ensuring that a big deal was agreed quickly, bringing forward a Wall Street payday.

A gloomy evaluation of Twitter’s prospects by its bank advisers was reportedly a key factor in the decision by the firm’s board to accept Musk’s offer with no real attempt to secure improved terms. Even the $1 billion fee agreed if Musk walks away from the purchase was lower than normal for a leveraged buyout.

So, can Wall Street’s finest – and some of their friends from Europe and Asia – now sit back and wait for their fees to arrive, before moving on to the next dealmaking triumph?

Not entirely.

The $12.5 billion margin loan component of the Twitter financing could deliver some sleepless nights for its participants as they monitor whether or not Musk is doing anything to erode the value of the Tesla stock he has pledged as collateral.

Morgan Stanley is providing the biggest portion of this loan at $2 billion, or 16% of the total. Bank of America, Barclays and MUFG have pledged the next biggest amounts at $1.5 billion each, or 12%. Then comes Credit Suisse at $1.25 billion, followed by seven other banks, including BNP Paribas, Deutsche Bank, Mizuho and Royal Bank of Canada.

With its spread of 3% over the secured overnight financing rate plus annual amortization at 5%, and a maximum initial loan-to-value rate of 20% for the collateral, this currently looks a fairly safe form of margin lending for the banks, with a healthy return on offer.

Musk would have to suffer a sensational fall in his net worth – which recently has hovered around $250 billion – before there was any reason to expect a direct threat to the margin loan provided by the banks.

But Musk is nothing if not sensational, whether he is launching rockets, feuding with fellow billionaires, or making impulse purchases of social media companies for $44 billion.

A dip in the value of Tesla’s stock after the Twitter deal was announced highlighted the speed at which Musk’s net worth can change, even if it did not immediately threaten his status as the richest person in the world.

The value of his Tesla stake fell by over $30 billion on Tuesday April 26, the day after the agreement to buy Twitter was confirmed.

It is still not clear how Musk will provide the $21 billion of equity he pledged as part of the $44 billion he is paying for Twitter, but if he simply sold Tesla stock it would leave him with a much lower shareholding to cover the margin loan.

If Tesla stock holds in a $900 to $800 range that would not be much of a problem, but if it were to fall much below that level banks would have to start worrying about his ability to cover the $12.5 billion loan.

When Twitter made what may be among its last quarterly earnings announcements as a public company on April 28, Tesla’s stock price took another dip to $828.

If the deal to buy Twitter were to fall apart before closure that would not be an issue for his bankers, except for some missed fees.

It is easy to envisage a scenario where Musk is saddled with a social media platform of uncertain value backed by diminished holdings in his publicly listed electric vehicle company, just as Tesla shares are falling, however.

It is also easy to see that scenario evolving into a crisis comparable to the Archegos disaster last year, when liquidation of shares held as collateral by the fund’s counterparts resulted in sharply uneven losses for its prime brokers.

Credit Suisse suffered losses of around $5.5 billion and Morgan Stanley took a hit of nearly $1 billion, while other Archegos brokers including Goldman escaped virtually unscathed.

A plunge in the price of Tesla, which on many days is the most heavily traded stock in the world, would spark increased volatility and higher volumes for the biggest equity derivatives dealers.

One of the top three global equity dealers – Morgan Stanley – will be exposed to Musk’s net worth via margin exposure if the Twitter deal closes as planned. The other two – Goldman and JPMorgan – will not.

Any trades that had the effect of exacerbating losses for Morgan Stanley could also impact the 11 banks that joined the margin loan to Musk.

There are other margin loans that could hurt banks in the event of a steep equity market downturn.

Mizuho is among firms that are exposed to margin loans made to SoftBank and its founder Masayoshi Son, for example.

For many big stakes borrowers, banks can take comfort from the current price of shares that are pledged for loans, such as SoftBank’s Alibaba holdings and Musk’s Tesla stake.

But managing the risk from these loans is an art not a science, and the Archegos scandal showed the extent to which bank counterparts can be in the dark about the real exposure of leveraged borrowers.

Morgan Stanley has plenty of potential upside from its current role as a trusted adviser at the court of King Elon. Private wealth management services to the richest person in the world could potentially form a healthy business line on their own, and other capital market mandates may follow the Twitter purchase.

But any missteps that anger the man who for a while used the title of Tesla’s techno-king on his Twitter account could have consequences, as JPMorgan has found in its dispute with Musk over the value of an equity derivatives deal.

And the banks that followed Morgan Stanley into financing the Twitter purchase, especially its margin loan component, could find that they have limited insight into risky exposure that is tough to manage in a choppy market.