When Chutzpah Became Credit’s Sixth ‘C’

Elon Musk’s acquisition of Twitter, Inc. has given the social networking platform unprecedented visibility in the financial press in 2022. Meanwhile, Twitter’s credit story—the rationale for lenders to lend—has gone dark.

In early January 2022, around the time Twitter sold its mobile app platform MoPub for $1.05 BN in cash, Musk began his stealth acquisition of Twitter shares. According to a press release from the class action law firm Hagens Berman, Musk’s undisclosed stake had exceeded 5% before the end of March. Musk continued to build his position silently, only on April 4 disclosing his 9.1% stake. That day, Twitter’s stock price shot up from $39.31 to $49.97, reversing a nine-month 32% decline.

Although equity and credit markets do not always see eye-to-eye, none of this early history contained any hint of bad credit news. In fact, Moody’s Investors Service’s in early April confirmed the ratings initially assigned in 2019: Ba2 corporate family rating (CFR), Ba2 PD (probability of default) rating, Ba2 unsecured notes rating and SGL-1 liquidity rating. Moody’s then followed up with a longer report highlighting Twitter’s business niche and net cash position as credit positives while caveating financial weakness and stronger competitors as credit negatives.

To put these ratings in perspective, Twitter is a Speculative Grade (“junk”) company. Speculative credits are more vulnerable to environmental and internal volatility than investment grade credits. The Ba2 rating level sits two notches below Investment Grade (Baa3) and a notch below the top speculative grade rating, Ba1. The 10-year probability of default for a Ba2 credit by Moody’s is between 10%-15%, but this is just an average. Twitter had negative earnings but strong liquidity for a speculative grade company.

The expectations underpinning Twitter’s credit were fundamentally shaken on April 25, when Musk, who by now held a 14.9% stake, made a take-it-or-leave-it bid to Twitter shareholders for $54.20 per share. Put aside the strength of Twitter’s brand and focus on the financial fragility of this $14 BN, loss-making company. Even if Musk got his billionaire friends to co-invest, the firm would still need a lot more debt to close the funding gap. Creditors would have to believe that despite now being on steroids, nothing would change when in fact every material credit dimension—all five of credit’s proverbial 5 Cs—had deteriorated.

If the first “C” is character, a leader who dithers is a decided credit negative. After leading with a bold offer, Musk dithered. Twitter shareholders sued him in Delaware Chancery Court to forced him back to the table.

The structure of Musk’s offer blew up two more C’s: capital and capacity. Twitter’s capital structure had been a good fit for the enterprise: 30% debt, mostly convertible, reflecting its upside potential. The buyout put $13 BN of new debt on Twitter’s balance sheet and $1 BN more in annual interest charges, straining the capacity of the firm to pay suppliers and creditors on time.

Finally, Musk’s rapid firing of employees, gutting of the existing governance structure and inflammatory mission statements sabotaged the fourth and fifth Cs: collateral (its client business) and conditions (Twitter’s uncertain future). Twitter’s solid-gold corporate advertising clients pulled back before the end of October. Keeping those advertising dollars flowing was not only the key to Twitter’s long-term economic viability but also to its capacity to meet short-term obligations. On October 31, Moody’s downgraded all Ba2 ratings on Twitter to B1 (22.2% probability of default), placing them on review for further downgrade, and withdrew the SGL-1 rating.

Musk once famously tweeted: “Moody’s is irrelevant.” Irrelevance became a reality on November 18 when Moody’s withdrew all its ratings on Twitter, claiming it lacked adequate information. Obviously Twitter had stopped talking to Moody’s. But since the credit rater got into hot water with the Department of Justice in 1996 for carrying out “unsolicited ratings” (publishing ratings without engaging the borrower), withdrawal was no doubt a prudent course of action—even if it left Twitter investors in the dark.

Comically, by playing the “Chutzpah” card, and cutting off Moody’s rather than try to wangle a better outcome for an impossibly battered credit profile, Musk probably negotiated the best possible credit rating outcome for Twitter under the circumstances.