Here’s Why Elon Musk’s Talk of a Twitter Bankruptcy Is Premature

In a call with employees on Thursday, Twitter Inc.’s new owner, Elon Musk, raised the specter of bankruptcy for the social-media company if it doesn’t start generating more cash.

Know why Elon Musk’s talk of a Twitter bankruptcy is premature. (REUTERS)

In a call with employees on Thursday, Twitter Inc.'s new owner, Elon Musk, raised the specter of bankruptcy for the social-media company if it doesn't start generating more cash.

It was a surprising scenario to envision for a company he had purchased for $44 billion just two weeks earlier, in part with $13 billion of loans from Wall Street banks. 

It may be nothing more than a scare tactic as he moves aggressively to reshape the company by slashing staff, shaking up its operations and doing away with Silicon Valley perks like remote work and free food. Musk has, after all, been known to throw around the B-word before ostensibly to motivate his workforce.

But few things about Musk or his acquisition of Twitter have been straightforward. And while the possibility of a bankruptcy anytime soon is unlikely, his comments shouldn't be entirely discounted. Twitter has taken on a large debt load. It's struggling with advertisers. And the broader technology industry is under mounting pressure, with behemoths like Facebook owner Meta Platforms Inc. retrenching sharply in the face of weaker advertising growth. With that in mind, here are three questions to understand about Twitter and the B-word:

Is Twitter really facing bankruptcy?

Such a step appears unlikely for now, and the discussion of it is, at best, premature. 

Twitter had $2.68 billion of cash and cash-equivalents as of June 30, along with another $3.4 billion of short-term investments, according to a filing. Even with Twitter's new debt load, that cash pile alone could keep the company running for a good amount of time. 

As the world's richest man, Musk also has plenty of firepower to keep the company afloat, and he could potentially inject more cash into Twitter if things became dire. That, however, would likely require selling more shares of Tesla Inc., a threat to the electric carmaker's stock price.

That said, even before the take-private, Twitter's financial picture wasn't great. The company hasn't been profitable for a full calendar year since 2019. And since the takeover, Musk has said that there was a “massive drop” in revenue as some advertisers fled from the platform. He also warned that the company was losing more than $4 million a day.

Where could things go wrong for Twitter? 

The debt. Musk borrowed about $13 billion from banks to acquire Twitter through a type of acquisition called a leveraged buyout. That's when the buyer loads up the target company's balance sheet with debt to help fund the purchase. 

The tactic has driven Twitter's annual interest expense to around $1.2 billion from less than $100 million beforehand. That's enough to consume a good bit of Twitter's annual revenue, which was approximately $5 billion in 2021. The situation could get even more expensive because the interest rates on about half of the debt aren't locked in and will rise with the market. 

An economic downturn, which is likely on the horizon, would also cause advertisers to cut back on spending. Musk meanwhile is charting a new course on content moderation, which has left some advertisers pulling back due to fears that their brands could be harmed.

So, what would happen if Twitter does ever end up in bankruptcy?

Shareholders bear the brunt of losses in a bankruptcy. That means Musk, along with a handful of other backers, would likely see their entire $33.5 billion equity investment go to zero. Since lenders typically receive a stake in the newly reorganized company in return for their debt being written down, Musk would almost certainly lose control of the company as well. That's normally how bankruptcy works -- and it effectively ensures that Musk would only take that step as a last resort.

The Chapter 11 process is meant to help a company restructure, not go out of business. Twitter could in theory rise from the ashes in this scenario, but under control of the banks that lent to the company. 

That's an unwanted situation for the Morgan Stanley-led group of seven banks that never intended to hold the debt in the first place. Normally they would have offloaded their debt commitments before the deal closed to money managers in the form of junk bonds and leveraged loans, but they didn't have a chance to do so because of Musk's sudden reversal to buy Twitter and market volatility.

Before Musk's mention of bankruptcy this week, some funds offered to buy a piece of the loan package at a discount of as low as 60 cents on the dollar. That would be among the steepest markdowns for such loans in a decade -- implying deep potential losses for the banks and that investors are already pricing in some default risk.

Now, Musk's comments will almost certainly make the debt even harder for the banks to sell to potential investors, who would likely want to see multiple quarters of good performance before they are willing to get involved.