With Elon Musk's deal to purchase Twitter (TWTR +0.00%) for $54.20 per share having been accepted by the board of directors, investors may be wondering why the stock is trading around $49 per share, a 10% discount. While this discrepancy may seem like free money, the reality of the situation is much more complex.
That 10% discount suggests that there is some doubt that the deal will go through. Some investors are wondering if they can pick up shares for a discounted rate with the hopes of selling them for the total buyout price. There are several factors those investors should be aware of before making a final decision.
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What if the deal falls through?
Even though the board of directors has accepted the buyout, nothing is stopping Elon Musk from walking away from his purchase except for a $1 billion breakup fee. Wouldn't it be nice if you received $1 billion if someone broke up with you? The breakup fee cuts both ways, as Twitter will be required to pay Musk the same if it backs out. As of March 31, Twitter had $2.28 billion in cash and $3.98 billion in short-term investments versus Musk's estimated $246 billion net worth. Twitter would be harmed more than Musk by backing out, leaving Musk as a more likely candidate to exercise this option.
Musk wanted to buy Twitter in the first place, so the odds of this happening are low. Still, the terms of the agreement state that Musk's Twitter activity must not "disparage the Company or any of its Representatives." If you follow Musk on Twitter, it's pretty clear he's done it already. However, this activity occurred before the April 25 filing laying out the terms of the acquisition, so Twitter executives obviously didn't like what Musk was saying about them on the platform.
Should this activity continue, Twitter may choose to pull out of the deal and cite Musk's "disparaging" tweets as the reason. In my opinion, this scenario is the most likely to cause a breakup. However, I still think the deal will go through as planned.
NYSE: TWTR
Key Data Points
As for when the buyout will happen, the deal must be closed by Oct. 24, 2022, or either party can walk away. There is also a six-month extension that could be triggered if an antitrust investigation takes longer than expected. Either way, both Twitter and Elon Musk are incentivized to get this deal done quickly.
However, this still doesn't stop either party from backing out or the government from blocking the buyout. If any of this happens, expect Twitter's stock to crash. Before Elon Musk took a position in Twitter, shares traded at around $39, which is where I would expect the stock to fall to if the deal fails.
If that happened, investors now would be facing a 26% loss. At that time, they'd be investors in Twitter's business rather than the buyout price and would need the company to grow over several years for the shares to return to their current price.
Is a 10% upside worth a 25% downside risk for a mediocre social media company? I can't answer that question for you, but it's a no for me.
Image source: Getty Images.
There could be tax implications
Should you decide to take this risk, there are some tax details you should be aware of. Unless you've held a position in Twitter since well before Musk initially got in, you will be subject to short-term capital gains taxes on your earnings. Short-term capital gains are paid on positions held for less than a year, and any profits are taxed as regular income, not at the long-term capital gains rate.
With just a 10% upside left in the stock, the U.S. government will take a healthy chunk of returns in the form of taxes. However, one could sell other investments at a loss to offset this gain.
When it comes to arbitrage investments (buying something at a discount to its actual value and then selling at the correct price), I leave it to the hedge fund industry. They will hear rumors sooner than I will and get out before something bad happens.
I'm also a long-term investor, and this doesn't fit my style. There's money to be made in Twitter stock, but I have no plans to buy in.
