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Chris DeMuth's State of the Markets October 2022 (with a large $TWTR focus!) (podcast #133)
Chris DeMuth joins the podcast to discuss the state of the markets in October 2022 and what’s catching his eye in event driven land, including a large focus on Twitter and some discussion on Spectrum Brands’ (SPB) DOJ case.
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Transcript begins below
Andrew Walker: All right, hello, and welcome to another value podcast. I'm your host, Andrew Walker. If you like this podcast, it would mean a lot if you could rate, follow, review it, wherever you're watching or listening to it. With me today, I'm happy to have my friend and the founder of Rangeley Capital, Chris Demuth. Chris, how's it going?
Chris: It's going well, thanks for having me on Andrew.
Andrew: Hey, thanks for coming on for the monthly bit. Let me start this podcast the way I do every podcast. First, a disclaimer to remind everyone that nothing on this podcast is investing advice. That's always true, but probably particularly true today since we're probably going to bounce through. I think we've got at least 2, 3, 4 stalks in different situations we're going to go through. So, everybody should just remember, please do your own work. Nothing on here is investing advice.
Then the second way I start this podcast is with a pitch for you, my guest, but we don't need to do that here. We do one of these state of the markets every month. I was actually teasing Jeremy Raper earlier today. I was like, "Hey, Jeremy, I think Chris has stated the markets today, makes him tied with you for most podcasts appearances." So, you're about to be the most popular podcast guest. All that out to wave, we are recording this Tuesday, October 25th. It is 10 A.M.. That timing might come into play if somebody's listening to this in the near future, we'll probably discuss, why? But I'll just turn it over to you. What's been on your mind trading the markets this month?
Chris: Winner has been on our mind a lot. I wish I had a more creative interesting novel out of the way, answer, but if you put me through with the truth serum, I'd say, that keeps coming up. It just won't die as the topic. If, and when it closes, I'm going to miss it in a sense because we've had some really good people to kind of work our thoughts through on this, and so in some ways, it's been a really good. It's been a diverse level of quality of analysis. I did some terrible and some excellent. So, that's been probably our biggest topic over the past month.
Andrew: Yeah. So, let's just give some background. So, again I mentioned we're talking Tuesday, October 25th, and that's really important because the deal is supposed to close Friday, October 28th. So if you're listening to this podcast over the weekend, hopefully the deal has closed, or else Chris and I are going to be going into a furious, mad dash to figure out what's going on. But we, in our September podcast, I remember we specifically said, "Hey, we're not going to talk about Twitter because there's a good chance that Twitter is - the trial was supposed to be last week actually. So, we said we're not going to talk about Twitter because we'll probably have so much Twitter news talk about next month.
There has been a ton to talk about this month, right? The trial got delayed because in early October, Elon Musk said, "Hey, I'm throwing in the towel. I'm going to close this deal by the end of the month. Stay the trial. Last week there were crazy reports about maybe CFIUS or National Security review with Elon on Twitter. Look, the stock is trading at, as we talked about 52.30, the deal which is scheduled to close on Friday is for 54.20. That's a 4% spread which might not sound like a lot, but if you've ever done merger arbitrage, a 4% spread for a 3 days to close like the IRR, and that is insane. So, clearly the market is still saying, "Hey, there's some chance Elon pulls some weird rabbit out of his hat and doesn't close, right?" So, I threw a lot out at you. That's everything I think that's happened since the last time we talked about Twitter. What do you want to focus on there?
Chris: I've been mostly fixated over the past few days on the national security issue. I would say that I was carefully following Elon Musk's tweets on opining broadly on Russia, and on China. I would say that there were some unnerving things he wrote. I would say that for the most part or maybe in its entirety, his tweets are well within the overtone window of the kind of things one could discuss and play society on foreign policy whether or not, it's advisable for a public company CEO to be talking broadly about foreign policy. I thought his views were fine. There were a few things that were a little worrisome that I would say were vernacular that would be found almost nowhere in American policy debate, but very specifically in the Kremlin phrases that are clunky in English that just come right from the original Russian that were awkward.
If I were professionally working on National Security, it's precisely the kind of thing that would capture my interest. So, the idea that people are looking at this as a defense contractor with secret clearance, it's just the kind of thing that would draw scrutiny appropriately. Whether that scrutiny is over Twitter, is a very different question. There were two things, and this really all came out of a kind of dramatic Bloomberg article, and it really kind of being discussed casually. We discussed it casually over the past few months, but it kind of came to a head with this Bloomberg article saying that there were concerns.
It really involved a situation where there clearly can be eager reporters, right? The reporters are going to all of their contacts trying to dredge up whatever they can at a deal that's getting this much interest from us and from others. People who are kind of broadly casually interested in this kind of thing, including sophisticated people and senior people and good contacts that one might have in DC, but CFIUS there's kind of two issues that I think are instantly important here. One is jurisdiction, and two is political jurisdiction. CFIUS is a serious organization. These are serious people. There's a range in Washington in organizations that are kind of on the pedantic side versus on the casual political side. There are some that are more easily weaponized against political opponents. I would put CFIUS at the very low end of that spectrum in terms of politicization. These are serious people. These are National Security people, and the staff takes their jurisdiction carefully, which [crosstalk]
Andrew: I want to pepper you with questions then, but let me just pause right there. So, CFIUS, a serious organization that you don't use to kind of harass political foes. In a perfect world, we'd hope no organizations are used to harass political foes, but would I be wrong in saying like we've talked about the FCC on this podcast? It's not necessarily the FCC is going to - I mean if you were a peer dictator you could use it to harass your political foes, but I do think the FCC in merger processes, they can flex their political leanings a little more. Would I be right to say you're kind of thinking about comparing CFIUS to the FCC there, or are there other organizations that you think could [crosstalk]?
Chris: That'll be in the middle. I would put at the very top the FEC, the Federal Election Commission where if we're running campaigns against each other, it's just kind of like part, it's custom to lob complaints against each other at basically anything you do. So, if you had a political action committee, anything you do, your opponents will claim was coordinated really with it. So, even if, I mean it's a perfect example of the process of the punishment, 18 months from now, they'll be a little blurb saying, it's exonerating you. But meanwhile, iit says "Investigation into illegal coordination with your candidate." That happens virtually every time. It is obviously by definition, an adversarial process when you're running for political office. But that regulatory body is weaponized as a political tool by both sides every time, and it's just a part of it.
Andrew: Let's just pause. We said CFIUS several times, just pause. We've mentioned it on previous podcasts. CFIUS is the committee for foreign investment into the US, if I remember that correctly.
Chris: That's correct.
Andrew: These are the people who generally when, especially China or maybe the Saudis, when they make investments into the US, they review it and say, "Okay, this is going into an industry that's not sensitive to National Security where it's okay for a foreign investor to own it." You could imagine if they were buying a railroad, maybe the CFIUS says, "Oh, we don't want foreign investors on any railroad because they could exert political leverage by shutting the railroad down or something."
Andrew: So, please, correct me, If I've said anything wrong.
Chris: That's correct. I would say there's a particular emphasis on technology because the railroad, we could always send the National Guard to take it back in a war against somebody. But if we sold a militarily sensitive circuit to a company that was a state-owned enterprise in China, we couldn't take it back. We can take the IP back the next day, necessarily. So, the reason why it's very focused on transactions, is very focused on IP, if you look through the past several decades, it kind of rises and falls with whatever the political concern of the day.
So, you have, it would be kind of concerned about Arabs during the oil embargo against Japan in the 80s. Generally, my view of the economics of it is, whenever they're these big kind of nationalist or even xenophobic worries that some foreign country wants to buy half your stuff, it's exactly the time you should sell them all of your stuff because they're almost always overpaying by the time people are worried like, "Oh my gosh. The Japanese are going to buy, they're trying to buy half of California." We should have sold them all of California because they were paying absurd prices.
Andrew: Buy back in distress.
Chris: Buy back in distress. Yeah, exactly. Literally, yeah, sell them all the state and buy back it, but that's been the history. Right now, it is very focused on China. It's directly China or even if we're looking at, say, the Dutch, so whether they will fall under our rules and concerns about China, so you know whether it would indirectly transfer. We kind of have a hierarchy of our top allies, and then kind of neutrals, and then ones that are a little concerned about and then China, but it's very China focused.
Andrew: So, look, anybody, again, anyone who's done a merger arbitrage especially when it comes to semiconductors M&A has CFIUS and actually China reviewing the semiconductor mergers. Those have been the two gating factors for all these things. So, let's go to last week.
Andrew: There's a Bloomberg article that says, "Hey, the White House has been concerned..." and I remember as you said, when Elon started dropping these tweets about Russia-Ukraine, it's never a good look when the Russian Embassy, thanked you for your talking points on Russia- Ukraine. You probably said something that wasn't so great, but anyway, he starts tweeting about Russia-Ukraine right after he announces, "Hey, I'm throwing in the towel on this deal." I remember people were sending around, "Hey is he playing 4D chess to get a National Security review to get him out of this deal?" I think both you and I said, " National Security reviews aren't generally something that you want to do."
Like that's kind of like not cutting off your nose to spite your face. It's cutting off your entire body to spite your face, but last Friday Bloomberg reported, "Hey, the Biden Administration is concerned about what Elon said and they're doing a National Security review to review all of his holdings." SpaceX is thrown in there Twitter's thrown in there. Obviously, for our purposes, the worry is Twitter. So, let's talk about Twitter. We said CFIUS is a lot, but if the Biden Administration was really concerned about Twitter, what steps could they take, what leverage would they have to pull? We can probably talk about why we hope, why we think, we're pretty sure that's not the case.
Chris: So, I wanted to go through the jurisdiction, the politics, and then also I'll tap briefly on the incentive from Elon's perspective. So, jurisdiction; a problem with CFIUS is the second word, foreign I guess, third word, if you count on, but the second letter in the acronym, foreign. Elon Musk is an American citizen, and his minority equity partners, some of whom are foreign, and some of whom might raise some issues, do not have control. The control issues in CFIUS is by statute and has been formally followed. No board seat. No observer status. No special information source. No Control. In fact, not even more equity passively than they have before when it was public. So, they don't have any increase in their status.
Elon is an American and so that should be that. If there was a different interpretation among staff, and I don't believe there is, then there is the issue that under the contract, the equity minority holders have to be approved by Twitter. They could simply reject it, and Elon is still responsible for his duties, which would require him to try to cooperate with not named CFIUS, but approvals and reviews that CFIUS would come under. My very strong sense is that this is something that they had been considering from the beginning, and even though they did not file a CFIUS application, they have CFIUS Council and CFIUS Council has been in communication with the government in a kind of collaborative normal way like any big company would on a big issue like this.
Andrew: Can I jump in on just one point?
Andrew: That was a great explanation. Right at the beginning, you said, "Look, CFIUS again, committee for foreign investment. Elon Musk is an American citizen." So, I wanted to ask two questions here; A, has CFIUS can or has CFIUS ever reviewed an American citizen's investment into an American company? That would be number one. Ignoring the foreign investors because again, I think Twitter could kick them out if there problems. That would be number one, and then number two would be, Elon, he's not just an American citizen, he has secret level security clearance from SpaceX. You can look this up. He smoked weed on a Joe Rogan podcast, and I remember viewers saying, "He's going to get his security clearance revoked because he smoked. He took a hit of weed," which was crazy.
But, considering he has security clearance, even with the American citizenship, isn't that like another thing that says, "Hey, if CFIUS is blocking this man from buying companies, how are they even reviewing this guy when he's got security clearance?" So, I threw two things out at you.
Chris: So, no, they did not investigate the American citizen. They have investigated deals with an American majority with foreign minority. So, the minority status is not a get out of jail free. In fact, in 2020, they've actually raised the standards for what could be reviewable. So, no, they've never reviewed an American for bad tweets, or for foreign-ish for the binary of an American citizen has been sacrosanct, so far.
Andrew: It's because I guess when we're like, "Look, I think it's extremely unlikely that CFIUS says anything here, right? But is it possible that at the last second like literally, we were 72 hours from close, but tomorrow, CFIUS says, "Hey, we need to review the minority investors. The Saudis are coming in here, and we don't like the Saudis having any say in Twitter. We need to review this." Then I think Twitter would you say, "All right , Elon, you got to kick them out of the group or whatever." Yeah. I guess it's possible, but I just don't see a way. Like the real risk is CFIUS says, "Hey, Elon, you owning Twitter is a national security risk. We need to review you and we might reject you from buying Twitter." I just don't see a hook for CFIUS to do that.
Chris: That's a zero. Of course, in Washington, you could always have incentives and jurisdiction be separated, so that they could be concerned about Elon, but use the excuse of the minority equity holders. Then Elon could contest or play fast and loose on the merger requirements on duties, which he's already fallen short of in other ways. Or play fast and loose about just not asking Twitter for approval, and then that would have to be litigated and change the course of the litigation. So, it's structurally conceivable that they have these two parallel concerns. One, is their subsidy concern, the other is their jurisdiction, but they do not have jurisdiction over Elon Musk in CFIUS, and they wouldn't try. Let me transition into politics because I think that's the jurisdictional answer.
Chris: What the politics would entail would be staff proposing this, which I think they won't. Then they would have to take that to the general counsel of the Treasury Department, who would have to approve it, and I think he would not. Then they would have to go to the treasury secretary who would have to approve it, and I think he would not, for increasingly political reasons because it'd be a really bad idea. I mean they have access to this tool, but they also have access to armed drones. I mean, they have access to armed drones with swords on them. They can kill one guy and not the other people in the room. So, it's cool tools, but not tools you would normally use against a domestic political adversary just because you have them.
The lawyers would get a little sniffy about suggestions otherwise, and then it would go to the White House. I think it would be stopped at every single step along the way, so there's kind of a series of people who would have to make a terrible political decision right before midterm elections.
Andrew: So, if CFIUS wanted to review this and stop this deal at this point, what you're saying is, it would take the general staff of CFIUS to say, "Hey, we think there's a national security risk here. We need to block, or at least put the steel on pause while we review the deal," which would go up to the general counsel at the treasury, then the treasury secretary, and then that would pass over to the president. So, every step people would need to say yes, to that.
Chris: Every step they'd have to say, yes. I mean, I guess we talked about the foreign aspect and not being a problem on jurisdiction. I would say the committee aspect would be a problem on both speed, and on a sort of innate conservatism in institutions like this from not being embarrassingly bad on the politics. Right, they may have a lot of sins of omission, but sins of commission just not cannot be bold and fast.
Andrew: When this article came out last Friday, I think the first email I sent you was like, to stop this, they'd have to block this within a week. I don't know if they could schedule a meeting within a week. That's just how committees work. It's really hard to schedule them, especially at that high up level.
Chris: This is almost a cliché, and I apologize and I said it in our conversation of this podcast in the past, but one of the biggest, probably the biggest differences living inside the Beltway in Washington between what it's really and outside theories. among smart sophisticated people who imagine is, it's just far too complementary to DC competence to imagine convoluted, sophisticated conspiracy theories. When they were asking about whether Trump was coordinating with the Kremlin, my answer was he barely coordinates with the White House. That they could do this very quickly and competently would require just an enormous amount of kind of political will. I think the political alignment would be opposite doing this now. So...
Andrew: No, go ahead.
Chris: So, I think, I still think the politics were bad and there are a lots of steps on the way for somebody to self-interestedly notice this before it's too late.
Andrew: Yep. So, I think we've talked about all the reasons why CFIUS won't do this. Why can't they do it? But let's just play out the political games a little bit, right?
Andrew: So, let's say CFIUS comes tomorrow and says, "We are pausing this deal on Elon Musk. The president approved it. The treasury secretary approved it. I mean, look, if they've got a text message from Elon Musk to Vladimir Putin that says, "Hey, Putin, baby. I'm going to take all of America's data and give it to you and I'm going to help you overthrow American democracy." Yeah, I'm pretty sure that they're going to be able to justify that in some way, shape or form.
Chris: Hey, and he could renounce his citizenship. Putin can give him a passport. He could renounce American citizenship. He can become Russian.
Andrew: So, we can go into all those angles. Like look, I do think people have to say, "Elon's a wild card, but if he does that type of stuff like you're talking about business self-immolation on an epic scale like, just to get out of Twitter, he's going to lose all SpaceX. He's going to lose. So, we can talk that route of people really who wanted us. I guess it's just you and me, so I don't know who the people would be, but the main route would be, let's assume that Elon hasn't done that, and the White House blocked this, right? I think there's two angles we can go. There's the immediate political implications, and then there's the long-term political implications. So, do you want to talk immediate or long-term first?
Chris: I would say immediate, and a couple of reactions. One reaction is, I wouldn't put it past
him to have a trick up his sleeve, but this would be about the sloppiest trick he could come up with because there's just no way to emulate a Twitter deal that he doesn't want, and protect SpaceX that he does. I think one of our colleagues who's been a long-term Elon watcher, really is good at keeping track of how thematically, Elon has this interest, they're largely space-related, and he's pretty consistent about doing all sorts of different things in a way that is kind of focused thematically.
It seems kind of chaotic in terms of organizations and things he says, but the one thing he does is he really does protect this Mars stuff. As a defense contractor of the secret clearance, you can't protect that and blow up Twitter. If you're going, to the Russian stuff - I mean one thing that's so interesting to me is we approach the geopolitics around China, and that gets increasingly fraught is, how much bigger China is than Russia? Russia is a trillion dollar economy and China's 17 trillion. I mean, there are provinces of China that probably the average person can't name that are much bigger economies than Russia is.
Andrew: It actually have to be changed. I mean, Russia's going back to doing things with rocks and stones.
Chris: It is such a big deal. So, if you're really going to sell out, so that's the Chinese. Don't sell out to the Russians. So, if we were in a completely moral framework, so, forget about patriotism for a second. Forget about justice or even just sensible, geopolitics, and just kind of think in mercenary terms and even set aside the law and say, which just rational and self-seeking? This would be a dumb move for Elon.
Andrew: Yep, and then on Elon's it would be dumb move, but I also think if you had it block politically, it would be a dumb move for the White House
in two ways. We'll talk long-term in a second, but in the short term, I sense you guys there was last Tuesday, Tucker Carlson ran a segment, and I only saw the screen shot because I don't watch this Fox News. But the screenshot was, "The last attempt to stop Elon from buying Twitter has finally failed," and this was last Tuesday. What I thought was curious about that was the news on a potential CFIUS review that we think is a long shot, came out on Friday.
The only thing that stops Elon from buying Twitter before last Friday or today or anything is, Elon stops Elon from buying Twitter because he came out with buts and all these other issues and finally tells him to stop. So, I was just looking at now saying, "Look, Tucker Carlson's running thing saying the left is stopping Elon from buying Twitter when it's completely not true three weeks before the midterms.
If they came out with a CFIUS block right now, it would be a political disaster. You would have every single Fox News segment, every single Republican senator would be going up, probably rightfully saying claims of, "Hey, we're hurting political enemies. We're controlling free speech." Like, all this other stuff would be an absolute disaster. What are we, 8 days from midterms? Like, I struggle to believe that. So, I'll pause there to let you talk about the very short term political implications. There would be longer terms too, but the shortest terms of political implications.
Chris: I think he's kind of one of the more interesting jump balls in American politics because he's not a conservative. He's not a Republican. He's not a traditional right-winger in any way, but
he's somebody who's tried to do business in California. I think that this is one of the most precarious things for Democrats going into a midterm. It's not people who are attitudinally against them, which is some part of the country, but a minority. I think the problem is when conservatives and normals are kind of added together, that is a majority.
So, you had people who don't like Democrats philosophically, and people who are indifferent or maybe mildly willing to go along with things, but are just terrible in practice such as trying to build a factory in California, is I think an honest liberal Democrat would say, "Well, that's terrible in practice." There are things that are tough on consumers, with prices that are high and the California political establishment's reaction is, "Let's, let's make supply harder and sub size demand to deal with high prices." Yikes.
So, I think that somebody who isn't kind of, I don't think he's spiking the football and a lot of this politics stuff. I think he kind of would have probably been happy to stay out of it, but if you look at his move to Texas, and if you look at kind of the number of people who follow him, including young people - one problem for Democrats is young people to be very apathetic about midterms. So, sometimes Democrats can kind of zoom on a presidential elections because younger people who are less consistent at voting and minorities who are less consistent at voting will vote presidential year not always the midterms.
Elon brings a lot of these younger followers in, and a lot of kind of non-traditional voters to the Republicans. That's the kind of doom scenario for Democrats. So, I think that they should be careful about that. Binds political machines pretty good, and they would not exacerbate that worry that they might have otherwise.
Andrew: Yep. So, that's the shorter term that like immediate. I think it's really bad for Democrats up and down the ticket unless again they can come and say, "Hey we're blocking this because of look at this text message to Vladimir Putin." Any other case, I think it's a disaster, but then politically fires up the other side, really demoralizing, all that sort of stuff. Then there's the longer-term implications and when you were talking CFIUS, you said, "Hey, first the committee makes the recommendation, they'll move up to the general counsel, then to the treasury secretary, and then ultimately to the White House. If you think about using CFIUS to punish political foes, I do think you're talking about it's something that's going to get reviewed. We saw on Friday, You and I were emailing. There's a senator, Senator Toomey, who I think is from Tennessee. I can't remember for sure.
Andrew: Pennsylvania. He said, "Hey, look, it's really concerning that CFIUS even leaked. There's that's concerning, but if this is actually the process, we're going to have a massive investigation." Do you think you have to think? If you use this as a political tool, you're not just talking about investigation, they will get to the bottom of that. I think it's impeachable at every single level. So, you're talking about a potentially impeachable offense to do a really bad idea to punish a political enemy over something that you know... Anyway, I'll pause there, or do you disagree with anything? Do you agree with me? What do you think of that?
Chris: I think that that is right. I think that you have too dangers, a small one, and a big one. This small danger you have is people who are deeply concerned about the due process in the Republican Party. Those people are few far between and politically imperiled now, Liz Cheney and Mitt Romney, they all have political opponents in some cases who will win in the coming years. That's a small problem as people who really care about the due process.
The big problem is the people who will get right back at you using the same tools and kind of every time, the Democrats look at something, that would be kind of weaponizing the process against domestic opponents. I would say, Donald Trump would be first in line but it'd be a long line of people who would do at least the same right back at them. That would be something that, with parity or close to parity in elections. possibly, for the next few cycles, would be worth thinking about.
Biden's been pretty explicit, and is kind of one government philosophy about using all sorts of different tools to coordinate a kind of coherent philosophical view on what they want government to do. They certainly have brought say, antitrust into that, but they haven't brought National Security into it. They haven't said, " We're going to..."They haven't brought armed drones into it either. I think, CFIUS would be on the kind of armed drones under the spectrum. Not the; let's use the antitrust to Pastor Jeff Bezos.
Andrew: One other thing that struck me about this is like, if you're scared that Biden's going to punish political enemies by using CFIUS like the way to punish Elon Musk is not to use CFIUS to block the Twitter deal. The way to punish Elon Musk is to let the Twitter deal go through, and let the man burn 5 billion, 10 billion of his own money overpaying for Twitter. So, it's just kind of funny. I heard several people be like, "Oh, using CFIUS to block Elon Musk." That sounds like something the political, the prior Administration would do. That sounds like using political tools to hurt your opponents. I was just going to think, actually, this would be using political tools to help your opponents, even though there will be a broad misuse of political tools, but I just thought that was kind of funny.
Chris: Yeah, no, and in this case, there really is no IP transfer. It's not the case that it would be with a kind of very advanced computer technology that once the eggs scrambled, they can't do anything. They absolutely have National Security jurisdiction after the deals done, So they don't really lose flexibility on Monday morning, if Monday morning. In fact, the deal's closed. The other thing about Twitter is, gosh, we've got an enormous amount of information on the company since the suit was filed and when they kind of went into data gathering on their users. I was a little disappointed as a Twitter shareholder. I thought they're going to have all these fantastic things of kind deep insights into every person. They kind of said, oh, well, we know their phone numbers, and they use it really, it was pretty crude stuff. So, even on the kind of data, kind of customer tracking doesn't seem to be all that important relative to what other social media platforms have.
Andrew: Yep. I totally agree. The other thing with Elon, at this point the three ways that we could not close our CFIUS review. I think we just spent 30 minutes talking about CFIUS review. I mean, are there any other tools the administration could use to block this, other than CFIUS? We've obviously very much focused on CFIUS?
Chris: I want to back up and say, I think my short answer is no, but I back up and say this administration has done several things that are outside of the jurisdiction and the tools that they have. They also can't simply forgive the student debt from a broad swath of society. They can't do number of things, they've demonstrably done already, says me, and says president. So, they have done unprecedented things that are broader than the authority that I think the executive has. So, I would be a little bit humble, so I would say no, they have to know their tools, I say, humbly and wearily having seen them do things that I don't think are permissible in the past already.
Andrew: So, I think the other two ways this could break between now and Friday - because again, this is supposed to close on Friday- are the banks could refuse to fund. So, that's your financing out, or the banks need a solvency certificate from Elon in order to fund this, and Elon could refuse to sign the solvency certificate and send this all back to the courts. Both are risks, but these are ones we've thought about a lot. I don't know if you want to talk about this state or process either.
Chris: Yeah, I think if you look at, since there's just nobody like Elon. There's nobody here who has so much wealth, and so much discretion to say and do wacky things. That he's sort of traumatizes us in terms of what crazy things could happen. He's wacky; Morgan Stanley isn't. When you listen to them describe their quarter on their call, their CFO said, "We we hedge. We're careful. We net out what we're making or losing on debt financing versus the very big fees that they get and against the relationship.
So you say, "Okay, you're clawing back 10, 20, 30 % of mark-to-market loss, which you're not even going to show because you kind of hold it on your books, initially. You clause significantly back just on direct fees, and then a lot more on the potential for a SpaceX IPO or kind of future business with a very wealthy person. I mean, if you look at banking relationships, you do a lot of kind of lost leaders for great relationships. So, neither that, this was bad, but not that bad and she sounded very under control and poise and normal as if they're just going to do kind of normal banking stuff this week.
Andrew: Look again, Elon has been a wild card, but I've always come back to like, "Hey, let's try and figure out what's most rational for all parties. Like I've said many times for the banks like, A; I knew they could hedge. Nobody knows if you hedge these things or not, but I do think it's common bank best practices, the day you put a commitment on their line, you hedge up every single thing you can do. So, they were going to make money on hedges every which way, but for them it was, "Hey, you have a contract that you signed. If you don't fulfill this contract, you're probably going to get forced by a court to fulfill it, and you're going to destroy your reputation along the way and incur millions and millions of dollars of fees.
So, why not just fulfill it? It just seems to me, and as you said, if you don't fulfill it, you don't get a lot of the fees that were going to come along with it, then you'll be forced to do it anyway. Who knows, if Elon rewards you or doesn't reward you for not doing it. But yeah, it just seemed to me from their standpoint , it made all the sense in the world to fund. I think at this point, we've gotten very consistent reporting from multiple credible sources, Wall Street Journal, Bloomberg and Faber, CNBC and all of them have said the banks are ready to fund this. It's funding this week, and guess what? Morgan Stanley basically said, "Yes, we're ready to fund this." So, I think financing, that kind of settles that up. What about i insolvency out.?
Chris: It would just go right back to Delaware. It would be novel. He could do it. So, I would never say, "He would never." It would certainly be a tone shift from the amount that Elon seems to be on board in his behavior with trying to talk up to the steel of this point, right? I think that it would be, I think most likely outcome of that would be, going back to Delaware losing on specific performance. But threatening possibly, both the debt and equity. So, he could be on, actually personally on the hook for 44 billion dollars.
I think he has a ton of downside there. Whereas, if he goes smoothly through this week, He'll have some equity commitments. He'll have the debt commitment and heck, he could even pull as Paul Singer did on Citrix recently. You could come back and Elon could buy some of that. Elon could buy the debt at a discount. he had work things out with the banks and kind of back into what they want to take. He could save a significant amount of money there.
Andrew: That's exactly it for Elon, a lot of people said, "Oh, take the insolvency out. Keep delaying this." My point was, "Okay. Yeah, you do it but it's not like it's risk-free to do it. You take the insolvency out. You're going to court, if and when you lose, you're going to have to pay a billion dollars for the specific performance. You're going to have to pay both sides legal fees which are going to run tens and twenties of millions more dollars, and you just claimed an insolvency out.
Right now, it's one thing to go back to your debt and equity partners, say, "Look, I was really concerned about buts, we thought about a lot. We were wrong, or maybe we think we're right, but we think we can 10X in 10 years anyway. We can really fix this platform. That's one thing. Going back to your equity partners 4 months from now, and saying, "Hey, I claimed Twitter was insolvent. Meaning I thought the business was worth less than 13 billion dollars. I'm going to need you to go ahead and pony up the 7 billion dollars of equity. "Hey, banks, I claimed Twitter was insolvent. I'm going to go ahead and need you to pony up the debt anyway." Like I think banks and equity partners are out in that case. Now, as you said, Elon's got a fun 44 billion plus specific performance, plus all the lawyers fees, like it's pretty irrational for him to do that, unless he really believes it, and he can prove it and he thinks he's got a real good chance of the judge awarding it, which I don't think any of that is true.
Chris: He seems to be shifting his energy. I mean, I think he wanted to be clever about the deal at this point. I think the tools in this tool kit include buying back debt at a big discount. I think he could do that. I think it's jawboning the head count down, which I think is absolutely consistent with his interest. I mean, I think one of the really interesting things here is that 75% cut, but somewhere between today's headcount and 5 is a number that's optimal. I think it is going to be very interesting if you can show how much he can cut while making a better or while preserving it.
Andrew: Did you see all that headcount count? The reports are he's going to cut 75% of Twitter's headcount. It doesn't strike me that it's not past me, yesterday an ambassador sent meta / Facebook a letter saying, "Hey, cut costs, cut employees." I look at Twitter's, Twitter is on pace to spend about 1.6 billion dollars in research and development costs this year. I look at the platform like, "How the hell are they spending 1.6 billion dollars?" I think everyone in Silicon Valley is going to be watching what Elon does with Twitter to see how lean these tech companies really could run because look, I don't doubt Google's doing interesting stuff in research and development. I also kind of doubt that Google's the best person to do it. It's kind of weird that a search engine is funding autonomous cars or something.
So, I think people are really going to be looking at this, and nobody's going to be an activist on Google or Facebook, but I think there are a lot of tech companies that if Elon's running Twitter with 25% of the employee-based. It's profitable. The service isn't breaking down left and right, a lot of tech companies are going to be seeing activists and private equity firms come to and say, " Oh, hello there, cost base?"
Chris: Yeah, and the skunkworks kind of a quirky step video on the side. I just think the market shift this year is going to have a lot less sense of humor for that. When you have a good platform, that's a profitable platform that just runs it for value, and then has something else, you either spun off. Pharmas, really kind of rationalized this. Almost always you have a big commercial pharma company and then you have the little biotech company. You really don't have big pharma wasting that much money on these kinds of novel things.
Andrew: Humorously, Valiant is one of the companies that kind of spurred that, that push them along that line, and then obviously blew up.
Chris: Yeah, but I think that that's going to be a tool and then of course, just encouraging people to leave in their own, which they kind of do sometimes sound a little spiteful, really services interest is much more financially attractive for him to come in with a lower count than having to fire thousands of people. It's interesting to see just in terms of how his reputation precedes him. The internal Twitter employee chats, people wondering if he has any tools to separately screw them out of comp and equity rewards that they have. Even after there are contractual promises, people have been saying, Print it out on paper so he doesn't come in and delete the server. the electronic records. Make sure you have backups on everything you have in your contracts.
Andrew: Look, a reputation is weird, but something this public, this visible, I think Elon's already done himself a lot of long-term damage with this, but if he doesn't close on Friday we've talked about all the ways it would hurt him. But another one is I think reputationally, if you go to a judge and you say, "Hey, I'm going to close this on Friday, and then you don't do it. Like, I just think reputationally, people are going to, it's going to have a longer term impact. We have talked a lot about Twitter. We've almost said our full-time cap here. I knew there were some other things we wanted to talk about. We can talk about them now. We can save them for next month, whichever you want to do.
Chris: I'm happy to talk about anything you'd like to discuss.
Andrew: Let's see. I know we've been looking at some other DOJ stuff. I don't know if you want to talk about that. A couple other things we've been looking at. I don't know if you want to talk about either of those, or what do you want to do?
Chris: I'll touch on the DOJ for a moment.
Chris: Whereas I think I sounded, in the Twitter case, where you have this kind of zany buyer, I would say sounded pretty respectful of CFIUS. I would say I'm extremely respectful of the chancery court. I'd say maybe put that at the highest end of the serious people doing serious work and not playing games. The DOJ, I would like to put up there, but has been kind of degraded in some ways in how political and how much kind of in the day-to-day political tussle they are. They've been losing a lot of cases. I mean, they've just had case after case stuffed back at them from judges. It's going to embolden parties to go to court, and take their cases to the judge. That'd be harder for staff to reach good settlements.
It's a DOJ, that doesn't seem to like settlements right now. So, that might be fine with them, but one of the very interesting ones that I would just touch on right now is Spectrum Brands, SPB, and it is a, not precisely a merger of situation, and that it's not selling the corporation, but a huge asset sale for the company with proceeds that would be more than the market cap of the company at this moment. Its high-end locks and fixtures for doors. It's the overlap, and reading through 60 pages of this, I realized how relatively dull the normal litigation that I look at. The normal kind of market definition stuff that I look at compared to, there were no poop emojis audit or anything like dealing with Twitter. So, it's just kind of reading all about this.
The government has a plausible case against it just in terms of market share barriers to entry and so forth. Like it. Don't love it. I think they could convince a judge except that the companies had offered to fix the whole thing before they had sued. This was not something where the government needed to push them. The companies came to them early on and said, "Here's the overlap. We'll clean, sweep the whole thing. So, it's as if we now have this government that just kind of revels in the fight that they just don't want to be seen kind of pushing their weight around.
They want to go to court. They want this battle, and the judge is going to look at this and say, "They're probably going to have a buyer in hand by the time they get to court in the spring. So, I don't know what the DOJ wants. They just want the spectacle apparently, but I think it's a very weak case litigating the fix. So, he is a liberal Democrat judge in DC. They will have to go to, but I think really despite the fact that somebody who's historically might be sympathetic to the government. It is consumers, the high-end consumers. It's not a particularly emotionally fraught cases if it was health care or tech where the government, really particularly concerned.
So, I think it's a weak-ish case until they find a buyer and hand. If they have a good buyer that can compete, it'll be a very weak case. The buyer of the assets very much wants to go through this deal and then the final thing, I'll just mention here is, the really interesting piece is if the DOJ is going crazy with a half dozen other suits. If they want to bring big suits against Microsoft and Amazon and Google of the same time, they may have to just settle this one because you could settle on a day in terms of companies have already offered just to get it out of the way, if you don't have enough litigators.
Andrew: For listeners, I did with my friend, PJ, we did an episode on Spectrum Brands. I think it was July, maybe August. This was before the DOJ actually came out and block this deal. We walked through all the fundamental values and everything there. So, I'll just refer you to that, and the stock was actually a decent bit higher because people thought this was going to go through. They didn't think the DOJ was going to block this. Just to give people an idea, this is right now, A 1.8 billion dollar market cap company. It's got three point three billion dollars in debt. So, about 5 billion EV. They're selling HHI for, I think it's 4 billion but the net proceeds to them after taxes and fees and everything is going to be 3.5. So we are talking about like this is a massive deal, right? This goes through and you can go look at how much the stock dropped when DOJ rumors of block happened when the DOJ block happened. I think there is a lot of upside here, and the downside, it was a big COVID winter.
A lot of the products home-and-garden that type of stuff were big COVID beneficiaries. There's clearly a lot of near term issues, but I've heard people say both ways. Like if you're kind of willing to look past the next couple of quarters, there could be a lot of downside here. Again, PJ went into all that. I want to ask you one question on this, Chris. So, I have a feeling we'll be talking about this more in the future on our future podcast, but just real quickly. This is a little different where most of the time when Arabs look at something, they're looking at Twitter, right? Deal is signed. If the deal goes through, we will get X dollars per share or we'll get shares of company or whatever. Deal breaks, and we're left with the standalone value. This are a little different words.
Deal is signed. If the deal goes through, the company gets the cash, and who knows what they do with it. If the deal doesn't go through, we're just left with the standalone business. Do you think this one is, I don't want to say flying under the radar completely because I have been approached by Arabs and eventually people about it, but not that much. Do you think this one is like a little bit flying under radar of different just because it's a big deal. It's a huge cash balance for the company, but it's not a, "Hey, the cash in your account. This is a done deal." So, maybe Arabs aren't quite looking at this one as seriously? Does that make sense?
Chris: Yeah, someone. I mean I think that when I was doing kind of before managing capital when I was doing consulting work for hedge funds, they were really these kinds of two classes. I think the one class that was very much exemplified by the prop test was a very narrow mandate. Very clear. We want no exogenous risk. We want just to capture spreads. We can call any medic[?] capital. We can lever up. We just need the things that won't break and that we can have even if it's a 3 or 4% annualized spread, that's fine. We'll just lever that up as long as it won't break.
Those type of our funds would have no interest whatsoever. There's the kind of broader kind of event, special sit funds that are willing and able to do interesting things. So, funds with broader mandates should possibly be interested in this kind of thing, but tight mandates and the kind of research services that just lists spreads will miss something like this. So, it could be kind of a little bit of an extra opportunity because of that.
Andrew: Cool. Well, Chris, I need top especially because we got to get this posted because if we don't get this turned around and edited quickly, it's going to go up and people will be like, "They're talking about Twitter. The deals are already closed. I mean, fingers crossed." So, I really appreciate you coming on. Obviously, we'll be chatting soon...
Andrew: … but we'll have another one of these probably around or after Thanksgiving. So, thanks for coming on, and I'm looking forward to that.
Chris: I think this is our last Twitter one, so we'll see.
Andrew: It's funny because we probably spent what 80-85% of the podcast on Twitter, and that's probably 80-85 % of my mind space. At least my mind space is getting taken over by Twitter these days. So, I have dreams every night about Elon Musk in Twitter closing. Oh gosh. I'm very ready for this to be done. We'll talk soon, Chris.
Chris: Thanks so much.