Monetary policy has changed since Elon Musk made his offer to purchase Twitter Inc (NYSE:TWTR) on April 14, and it's going to cost the billionaire more to complete the acquisition now than it would have if the purchase was completed in April or May.
The Economic Backdrop: The Federal Reserve has increased interest rates five times in 2022, including three times in a row at a rate of 0.75%, and indicated that further significant rises were expected.
Since Musk’s initial offer, the Nasdaq Composite and S&P 500 have plummeted by roughly 16% and 14%, respectively.
We know that while the Fed has been raising rates, other key indicators — like mortgage rates and auto loans — have been rising in lockstep, as when the Fed Funds rate increases, it becomes more expensive for banks to borrow from other banks.
Read more: BENZINGA TV EXCLUSIVE: When Will The Fed Stop Hiking Interest Rates?
Twitter Deal Gets Pricier: When the Fed raises interest rates, credit debt becomes more expensive. That’s because the interest rates on consumer debt, like carrying a balance on a credit card, tend to move in lockstep with the fed funds rate.
This key interest rate impacts how much commercial banks charge each other for short-term loans. A higher fed funds rate means more expensive borrowing costs, which can reduce demand among banks and other financial institutions to borrow money.
Musk’s $44-billion deal is to be financed by $12.5 billion of debt and equity capital from Musk himself and others.
With interest rates spiking, this suggests “pre-tax interest costs for this debt could approach $1 billion, for a company that we model as on track for close to $1 billion of adjusted EBITDA this year and close to break-even free cash flow,” Rosenblatt Securities said in a note to investors on Wednesday.
What It Means For The Banks: The banks that are financing the deal could lose hundreds of millions.
As in any large acquisition, banks would look to sell the debt to get it off their books. Investors have lost their appetite for riskier debt such as leveraged loans amid the uncertain geopolitical and macroeconomic environment.
Leveraged loans totaling $6.5 billion, secured bonds worth $3 billion and unsecured bonds worth another $3 billion make up the debt package for Twitter.
"From the banks' perspective, this is less than ideal," said Wedbush Securities analyst Dan Ives. "The banks have their backs to the wall - they have no choice but to finance the deal."
