Will Elon Musk Outwit Twitter in Lawsuit?
Twitter is suing Elon Musk for backing out of merger agreement. But Twitter may have fallen into a trap that has been laid by Mr. Musk. One that could benefit Musk regardless of the outcome.
BBC reports that “Twitter is suing billionaire Elon Musk to force him to buy the social media firm. This is going to set up a battle with the world’s richest man. After Musk said he was going to walk away from the $44 billion takeover deal because of the number of fake bots and spam accounts that are on the platform.”
Now, Twitter has filed a case inside of Delaware court, where they are claiming the following:
“Having mounted a public spectacle to put Twitter in play and having proposed, and then signed a seller friendly merger agreement. Mr. Musk believes that he, unlike every other party, subject to Delaware contract law, is free to change his mind and trash the company, disrupt its operation, destroy stockholder value and walk away.”
The lawsuit is actually blaming him, not only for trying to get out of this contract, but also to destroy value to the company. Accusing him of personally causing some of the damage himself to the company, which I think will become relevant, when the case is going to be litigated.
Like everybody else I’m interested in what is going on with this celebrity, one of the smartest people alive today. I came across this information on CNN business where Professor Scott Galloway, who is a marketing professor is discussing this lawsuit. He seems to think that Elon Musk is on the hook for more than a billion dollars. In fact, he thinks that the settlement is going to be in excess of 10 billion when he’s pushed to answer that question in a lightning round.
I was wondering, if that were really true? Would the smartest person alive, someone who seems to always be winning, succeeding when it comes to business and defying the scientific odds, be willing to do something that was so stupid? I’m a little bit skeptical about that.
I decided to take a look at the other side of the argument. According to Mr. Musk’s lawyers: “Twitter’s representation in the merger agreement, the accuracy of its SEC disclosures that are related to the spam accounts, the false accounts are likely to have caused what is considered to be a company “material adverse effect.” That phrase, material adverse effect, and its legal definition and criteria, may form a legal basis for Musk to terminate the merger. “While Mr. Musk and his advisor continue to investigate the exact nature of the bots, Mr. Musk has a reason to believe the true number of false or spam accounts on Twitter’s platform is substantially higher than the amount of less than 5% represented by Twitter in its SEC filing.”
To summarize, Twitter has made these representations in their SEC filings — that less than 5% of their accounts are fake and Musks team doesn’t buy it. Instead, his legal team is arguing that it could be much greater than that. According to them, it would cause a materially adverse effect, which for now, lets just say means, as it sounds, that the financials of the company will change substantially because of something that has taken place. That would affect somebody’s willingness to buy something at a particular value and therefore, can be used to terminate an agreement.
Professor Galloway continued that the merger agreement was an airtight contract, more potent than over 90% of agreements. While that may be true, it might not be relevant. It would be important instead to focus on the agreements that have gone in front of the courts.
Mr. Musk’s representatives point out that in section 6.4 of the merger agreement that Mr. Musk is “entitled to all information concerning the business of the company for any reasonable business purpose related to the consummation of the transactions.” Furthermore, under 6.11 of the merger he’s entitled to “ information reasonably requested in connection with his efforts to secure the debt financing necessary to consummate the transaction to that end.: On June 17th, Mr. Musk requested “a variety of board materials, including bottom up financial models, a budget for 2022, a draft plan or budget, and a working copy of Goldman Sachs valuation model, underlying its fairness opinion.”
However, Twitter provided only one of these requested documents, a Golman Sachs final board presentation. Therefore, Musk’s team would argue, that they reasonably requested information concerning the business, in order to consummate the transactions of the business. According to section 6.4, these requests all fall under information concerning the business used for “any reasonable business purpose.”
Those are pretty broad terms, and I suppose it will come down to how Delaware goes ahead and interprets them in court.
Despite these claims, Professor Galloway seemed so certain, he pondered that the Delaware court could enforce a ruling by jailing Mr. Musk, because his violation is so egregious, he really has little argument.
Looking at a little case law, the term “material adverse effect” is so important because it comes up in the determination of enforcing merger agreements in Delaware. The first such case was the Acorn case. Actually it’s the first Delaware case where a party was actually entitled to terminate a merger agreement based on this concept of material adverse effect.
The thresholds of what was constituting material adverse effects was explained further in a later case where the threshold for MAE was not met. It was between Med systems Inc versus Boston scientific corporation. It’s known as the Channel case. In the channel case, the court opined on the rulings of the acorn case.
According to the courts material adverse effects could be determined by considering through quality or quantitative analysis. The threshold for meeting the burden of MAE had to be greater than the “risk” of adverse consequences. This would be easier to demonstrate using a quantitative matter. In the acorn case, a 21% decline in standalone equity value was sufficient to establish material adverse effect.
Share price could play a role in the Twitter V. Musk case if a quantitative analysis is applied. If we look at the price of Twitter post merger announcement, we could observe that it has declined substantially. The price could be used as evidence that, is in fact, somewhat relevant. The position of Twitter, however, could be that the Twitter decline is related to the overall market conditions.
As far as a qualitative issue, the question in the courts is whether there is an adverse change in the target business consequential to the company’s long term earnings power over a reasonable period, measured in years rather than months.
It seems to me that the number of users is something that is very important to a social media company and more likely to play out in the longer term.If you could establish Twitter has 20% bots or 50% bots, they might have half as many users as they claim. Of course, that would dilute future earning related to marketing. Especially if it means marketing is going to people that aren’t real! Therefore, I believe the bot percentage will be a reasonable argument, for Elon Musk, to establish a material adverse effect,
As mentioned above, according to the acorn case, a 21% decline and standalone equity value alone is sufficient to establish a material adverse event. Twitter and Musk’s team will argue over whether the fact that Twitter stock is down so much has something to do with this. If you review the pricing following the merger agreement on April 25th, the stock of Twitter went at first went up from somewhere around a close of 47 the day before, to a close of 51. In the three months afterwards, however, the stock is down about close to 30%. Of note, the Tesla stock is also down around the same amount, post announcement, so I’m sure Twitter could argue, that the stock price has nothing to do with these bots. Therefore there’s no reason for us to be providing any information about the bots. Perhaps that is true, but doesnt it still represent a decline in standalone equity? Tesla’s value should not be relevant to the situation because they’re not the ones being questioned, in terms of a merger agreement and a material adverse effect. Furthermore, they might argue that if Twitter is going to be taken private its price should not be coupled with the market but should mimic a bond price closer to maturity.
Why didnt Twitter provide Mr. Musk with the Bot data? Do they even have it? It seems to be something a purchaser should be entitled to, that they should have provided to Mr. Musk. Now, the fact that it’s a purchaser or a seller friendly agreement, I don’t know if that’s going to make a difference in court.
I think Mr. Musk will get what he wants. It’s hard for me to bet against Mr. Musk because Mr. Musk tends to win in confrontations, whether they involve the SEC or hedge funds shorting his stock. If we take a step back from the lawsuit and think about what Mr. Must asked for it might reveal some of his strategy. He wanted to know what the bot percentage was. If the bot percentage was 5% or lower, he would purchase twitter. If not, the risk might be too hot for Elon.
In the end, I think the case will get him the data to make an informed decision. If not supplying the bot percentage constitutes a materially adverse effect, they may have to supply the figures to win the case. He can then happily purchase Twitter. If they can’t or they choose not to, perhaps it will further support the fact that it is materially adverse. In summary, I think this is a game to get Twitter disclose the information.
Meanwhile, Musk has time on his side and Twitter stock is not doing very well, so there will be pressure to negotiate a settlement. The longer Twitter waits, the more bot rumors will circulate. Under the microscope of this deal, what if some other skeletons make their way out of the closet? It could spell disaster for Twitter.
This is a really screwed up game of chess. On one side is Musk on the other Twitter. Unlike Chess, where you defeat your opponent, the loser here gets to take/retain ownership of the company. Musk is being sued to take over a company. It’s kind of a strange position to be in.
Back to the bots for a moment. Perhaps, Twitter doesn’t know how many bots exist because they don’t want to know. It may be advantageous for them NOT to know the precise number. For example, let’s say the number actually is around 60% what do you think would happen to Twitter? Proceeding with a legal battle may force them to quantify the number, in order to prove that it’s not materially adverse.
I can’t stop thinking that Musk’s thought process is informed by quantum Mechanics. When interviewed, he says he applies physics principles to business decisions. What can we learn from Quantum Mechanics that could be applied to litigation over a pending merger agreement or disputed bot percentages?
One of the principles in quantum mechanics is that small things may exist as particles with a definite location or as a wave without a precise instance. Accordingly, one of the mysteries of quantum mechanics is that we can’t know both simultaneously AKA Heinsberg Uncertainty principle.
Since we can’t know both its wave property and exact measurement as a particle, the act of measuring a particle brings the particle into a definite state. This could be analogous to the probability of bots causing a material adverse effect in this case.
We could think of the percent of bots in a bell curve distribution with different probabilities. Each bot percentage may fall within a certain range. When the bot percentage is unmeasured it cannot cause a material adverse affect. Instead it exists in the abstract realm of probabilities. However, when it is measured and quantified, the bot percent can cause an adverse effect.
The analogy follows that the act of measuring the bots precisely may trigger an adverse effect. But until Twitter specifically and reliably measures the number of Bots, the (chance of a) material adverse effect doesn’t actually exist. If it does, then Mr. Musk will have won his case. It is also possible that after measuring the bot percentage, it will remain around 5% and no material adverse effect will exist. Elon Musk can then proceed with purchasing Twitter. In either case, it seems the outcome will favor Mr. Musk.
