Motley Fool Hidden Gems Investing - “Can we pour one out for the lawyers?”

Episode Date: April 14, 2022

Elon Musk offers to take Twitter private in an all-cash deal. (0:14) Dylan Lewis and Bill Mann break down: - The details of Musk’s offer. - How the market is pricing in the probability of this takeover. - The issues at Tesla that may also warrant Musk’s attention right now. (14:02) Ricky Mulvey interviews Asit Sharma about how investors can find stocks with “escape velocity,” and one cybersecurity company that may have “overcome gravity”.   Stocks: TWTR, TSLA, GS, NVDA, CRWD   Host: Dylan Lewis Guests: Bill Mann, Asit Sharma, Ricky Mulvey Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

Dylan Lewis. The Twitter Elon Musk saga just got a lot more interesting. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined by Motley Fool Senior Analyst, Bill Mann. Bill, it's not every day that one of the richest people in the world decides to make an offer on one of the most visible media brands in the world. I don't know what you're talking about, Dylan. I haven't seen this news at all. You're going to have to enlighten me. Well, for anyone who maybe didn't check the internet today, in a letter to the chairman of Twitter's board yesterday, Elon Musk wrote, I am offering to buy 100% of Twitter for $54.20 per share in cash, a 54% premium over the day

before I began investing in Twitter, a 38% premium over the day before my investment was publicly announced. My offer is my best and final offer, and if it is not accepted, I would need to reconsider my position as a shareholder. Twitter has extraordinary potential. I will unlock it. Bill, what was your first impression hearing about this? I think, first of all, we need to acknowledge that the CEO of Twitter, Parag Agarwal, has had perhaps not the paternity leave that he was expecting when he announced in February that he was going to take some time off for the birth of his second child. He's been busy thanks to Elon Musk. So this $41 billion cash offer for $54 a share is something that the board at Twitter is

going to have to take seriously. Cash offers mean at the end of the day that shareholders are going to get bought out. So a lot of the things that you would think about from a merger where there's a stock transaction are a little bit different here. At the end of the day, they're going to get cashed out if this deal is accepted. Really, the only element that they have to be focusing on is, is this a sufficient premium to sell the company? I can't wait for Agarwal's memoir on his first year working as the CEO of Twitter. This is someone who has been sitting in the executive chair since November of 2021. This has been an incredible first six months at this position. He's been with the company for a while, but no one could have possibly

anticipated that this was going to be coming. Knowing that this is a deal that has to be taken seriously, what do you make of it in a financial sense? From a financial sense, it seems that there are so many different things, Dylan, about this. Honestly, I can't get enough of this story. There are so many things about this that are just short-term bonkers. So, like, for example, Twitter has gone out and engaged Goldman Sachs to advise them on the deal. And so, presumably, when you go out and get an investment banker to advise you, they're going to come back and say, well, you know, this deal, it's just not quite attractive enough, which goes, you know, which will put Elon Musk's words like, this is

my final offer to the test. Goldman Sachs has a sell rating on Twitter with a $30 price target. They are simultaneously saying that the company is overvalued, and then some other component of Goldman is going to come out and say that this isn't enough money at, doing the math real quick, 88% higher price than their price target for the shares. There are a whole lot of things about this that are completely unusual. It's a good reminder there about the incentives at play, even from the same firm looking at a company in the financial services industry bill, right? Yeah. And it's not to say that, you know, Goldman will say that they've got what they call Chinese walls in between these components of their

business. And so it's not 100% without precedent that they would do something like this. But, you know, from an outside view, it's going to be pretty easy for Elon Musk to say, Well, how how can you as a corporation, how is you an advisor as an advisor have both of these views? What's really interesting is that Elon Musk. I mean, I guess you probably see things coming out later. And again, from the time that we record this to the time that it goes out live, thousands of different things might have happened in the interim. But as of now, 1.15 in the afternoon on the East Coast, he hasn't put out a plan. He's just said he's going to be able to unlock value at Twitter. We don't actually know what that is. And again, in some ways, because it's a cash offer, it kind of doesn't matter that much. But it will be

fascinating to see if he does come out with a plan. Yeah. And I'm sure that there are shareholders that look at this very differently, depending on when they became a Twitter shareholder. I mean, it's a nice pop on where the company has been over maybe the last couple months, but you don't have to rewind too far to see people have a cost basis well above this offer price, even within the last year. Yeah. And one of the biggest shareholders of Twitter, Prince Alwaleed of Saudi Arabia, has already come out and said, this deal's priced too low. I do not think that this is close to the value that I would expect Twitter to be at. And you would expect the largest shareholder to come out and say such a thing,

and it could be posturing or it could be something that he absolutely positively believes that Twitter is going to be more valuable as an operating company. But I can't figure out, Dylan, for the life of me, who is having the hardest time right now, because it bears remembering that Elon Musk came out and filed a 13G originally, and then he filed a 13D, which is something that you would have to do as an activist shareholder for the 9.4% stake that he's already acquired. Now he's come out and he's trying to acquire the entire thing. Now, I'm not a securities lawyer, but I'm pretty sure that this is not how someone is supposed to do. This is something that is going to attract interest from the SEC. So, you know, Elon Musk has been a magnet for interest from the

SEC for a long time. And I don't think that he minds that all that much, but you've got to wonder who has had the hardest week, whether it's been the management at Twitter, whether it's now the board at Twitter or whether it's actually the SEC. Yeah. I would say Musk's lawyers have probably also had a hard week. Can we pour one out for the lawyers? Something you would never, ever say. Well, yeah, we have, you know, this is all in the public eye happened really over the last two weeks. We have the 13G filing rather than the 13D filing, and we had the corrected filing that got later pushed through. We had he's joining the board. Just kidding, he's not joining the board. And I think there might have been some posturing there, both by Twitter and by Musk, on trying to

limit the reach that he would have with this organization. I know one of the first things that came out as we were looking at whether he would join the board is, would he be okay with capping his ownership stake. And I think as that became something that was clear as part of that board seat, we realized, no, he's not going to do that. No, exactly. And, you know, I think it's important to note, uh, that a lot of that Twitter does not have a dual class shareholder structure in place. So if he pushes, I really think that he will be able to get this transaction done, even if he has to go hostile with them. He's a master of the narrative. You know what's not being talked about right now? Supply chain issues at Tesla. Suddenly, what's going on in

Shanghai, the factory perhaps being impacted by the zero COVID policies in China, nobody's talking about those at all because we're talking about what, I mean, really honestly for Elon Musk is pocket change, what he might be doing at Twitter. And he's entirely in the driver's seat here. I mean, he wrapped up this filing. He said, best and final. I am not playing a back and forth game. We'll have to see whether that's true or not. He's moved straight to the end. He says, this is the high price and your shareholders will love it. And he ends, and I think this is important to zoom in on, if the deal doesn't work, given that I don't have confidence in the management, nor do I believe I can drive necessary change in the

public market, I would need to reconsider my position as a shareholder. Oh, my gosh. It's truly, hey, nice company you have here. Be a pity if something were to happen to it. Yeah. It's a little bit of a strong arm, isn't it? From his perspective, he basically has the opinion that I can own this outright or I'm going to walk away from it. And walk away from something that may be greatly diminished just from the point of my adventurism to this point. Again, what an unbelievably bad paternity leave. Yeah, just unbelievable timing. And I think to bring this down to the average investor, Bill, it's easy to look at these types of headlines,

these types of moves, and say, well, this offer price is above where shares are currently sitting. We have to price some risk in for that. And that's why we see that in the market. If I'm sitting on the sidelines and interested in this, what should I be making of this whole saga and where this can go? And I think that the answer, based on the past and funding secured with Tesla, is don't bank on any deal necessarily. And the market absolutely is not. And once again, there will be a little lag in between the time that we have this conversation and people are able to access this interview. But at the moment, Twitter is trading about 20% below what his takeover price would be. So the market does not necessarily believe that a transaction is going

to happen. I wouldn't begin to know how to handicap this. But if you believe that Elon Musk has the capacity to make this transaction, that's 20% of money that is sitting on the table for the taking. Now, Dylan, I have to say, I don't think ultimately that this is going to go through, if for nothing else. I mean, good gosh, could you imagine Elon Musk becoming the person who is responsible as the spokesman for Twitter, being hauled before Congress whenever they have their nerd forums. They bring in Tim Cook and Elon Musk is one of them. I just don't think he has the stomach for this. That sounds like his nightmare. It sounds like fantastic, fantastic content for us.

Yeah. There's a lot of really good fodder in that. I don't think that's where he wants to be spending his time on Capitol Hill. I really don't either. And on the note of that discount that we're currently seeing and maybe the opportunity that some people are seeing that before I joined The Fool, I worked at a place that had a merger arbitrage division. And my boss very eloquently described it one time as trying to pick up pennies in front of a steamroller. That's right. In this case, you're trying to pick up because there is a pretty substantial discount. Usually when there is a transaction announced, there's funding in place. They come out with a full plan. And usually you will see the market get it pretty close.

it'll be within 1% or 2%. So, 20-some-odd percent is a remarkable discount. But this is really a transaction almost without precedent in terms of its structure and in terms of its implications. So, I love having opinions on things. I bet you your old Berger Arbitrage boss is having a field day with this. Yeah. I think it's probably a busy day at the office for them. for folks that want to get a better sense of where this story isn't going and what the next steps are, what can we be watching for in the timeline? I think what you're going to see next is a response from the board. And it could be one of two things.

It could be an outright rejection or it could be a, a feeler for whether this really is his, his highest and last offer. So the next step is going to come from the board. and I don't think they will take very long. So, again, they don't have, at Twitter, unlike a lot of other companies, they don't have much of what they call investor protections in place, which are actually business protections. They don't have a poison pill. They don't have a dual-class share structure. So, they are trying to figure out right now whether they are dealing with an honest broker in Elon Musk because they have to. They, unlike Elon Musk, have a fiduciary

responsibility to shareholders. So they have to respond to him in an honest broker way. So the next step is going to be a response from them. And you will see almost instantly in the share price what that response, what next steps are going to come from that response. Hopefully that doesn't happen in the next two and a half hours and we can put the show out As recorded. Bill, thank you so much for joining me. Thanks, Dylan. Twitter's been a gathering spot for investors discussing stocks poised to go to the moon. Producer Ricky Mulvey and Asit Sharma borrow another celestial metaphor

to talk about companies that can weather the current tough environment for stocks. When you hear the term escape velocity, you might start thinking about rocket ships, but you might want to start thinking about stocks. Joining me to discuss why is Asit Sharma, a contributing learner and a senior analyst for The Motley Fool. Asit, good to see you as always. Yeah, same, Ricky. And this isn't some story about me wanting to grow up to be an astronaut. I never had that aspiration. I think it would be fun, but then I realized how long you just have to spend in space by yourself or with a small group of people, and that terrifies me. Yeah, and there were those songs like Elton

John had Rocket Man, which made it sound not so appealing to be up there for a long time. So, there's that. Yeah, Alien. There's some spooky stuff going on in space, but you've been thinking a lot about the concept of escape velocity and how it relates to different stocks, and you said, we've got to do a podcast segment about it. I guess, what got you thinking about it? Essentially, why should investors care about this concept? Ricky, I was working with some fellow analysts putting together a service at The Motley Fool. We are in a different environment in 2022. We have to focus on where the market is pushing interest rates. We have to focus

on inflation. That affects how you look at stocks. This meant for us, maybe trying to find a balance between two poles of stocks. We still love growth stocks. We call them catalysts in the service, but we love compounders too. The only thing was, as we were thinking through this, a compounder sounds like a boring type of company. Who wants to buy an annuity-type business, you always want a growth business, even if it's a more steady grower. This got us thinking, what if you find companies that have really gotten beyond that stage of boring growth? They're never going to be catalysts again, right? But they have been able to get past their limits. This is where the idea of escape velocity comes in. You need a certain

amount of force and speed to escape the gravitational pull of a larger object. Yeah, you need speed, but I think it's a little trickier with stocks, but the analogy still works. When I think of escape velocity, it doesn't matter how large that object is. But I think it's a little bit different in the stock market, because you've talked about it from a way that a very small market cap company would have a more difficult time achieving escape velocity than something with a larger market cap. Yeah. A small company which has a lot of growth potential, a lot of revenue growth ahead of it, and earnings power, that might seem like an escape velocity company,

but it's really not. Think of that as a company that is on the launch stage. It's still got to fire those boosters and accelerate. We're thinking more about that constraint of gravity. Gravity can take many forms. Competition is one. If you have a company that, when it was younger, was fighting against the competition, but now has reached that stage where competition is less of a risk, it's more about extrapolating increasing value out of a market, NVIDIA for me comes to mind as a company that's done that. I mean, sure, it competes with other big semiconductor companies, but it's got its niche and it's really broadened out into several revenue streams. And now for Nvidia, it's about growth. It's about making sure

that it plumbs every available market, whether that has to do with automation, whether it has to do with virtualization or the chips we need in gadgets. This is something that every company aspires to, but few companies can get beyond that initial gravitational pull. Is it just competition, or do you think there are other gravitational forces that would prevent a company from achieving escape velocity? I think there are several. Foolish investors know that so much of a company's success comes down to its people. And when a company is in the early stages, when that rocket ship is rolled to the launch pad, we don't know a lot about management. We get to observe

truly great companies, the ones that aren't merely compounders, but the ones that are just doing that extra bit of value creation. And we get to observe how management makes its capital allocation decisions, how they react to crises, the people they choose, the people they hire. This helps you escape gravity once you've got that team in place and they execute year after year after year. You see that effect stronger and stronger. Helps get to that constant speed that you were talking about. We also talk about gravity as this, well, if you're talking about the traditional rocket ship, gravity is going to stay a constant. But I think, in a sense, for stock investors,

you're going to have different gravities for different companies and different industries as well. When you think of a company that's escaping that gravity, that's achieving that escape velocity, you're saying you don't measure it on the ground, you measure it closer to the atmosphere, maybe where the satellites are in space. What's another example you think of a company that's maybe close to achieving that escape velocity, not the size of Nvidia, but has the chance of getting there? I think there are many companies that fit the bill. One that comes to mind is CrowdStrike. This is a company that plays in a really fast and evolving market.

That's the cybersecurity market. It has an amazing platform, which has attracted a lot of enterprise customers over the last several years. Their net dollar retention rates are really high. The company has a history of growth, but despite having fierce competition from companies like SentinelOne, which is a peer in this space, and other cybersecurity companies, they have this ability to penetrate the market. There's still a lot of growth ahead. But now, you can worry a little bit less about the competition. It's like they're proving themselves as a quantity out there in this industry. This is a company that I think is very capable of reaching that escape velocity. To use your analogy, yeah, it is higher up.

It's left that stage. It's approaching that stratosphere. You could see at a certain point in time, with the deep relationships it has with its customers as they stay on its Falcon platform and they sell more products to these customers, they could keep going, maybe never constant speed. That's one reason I appreciate you so much, Ricky. You're really great at punching the holes in the analogies. We should say, as you and I were chatting about before we came on this taping, in space, once you reach escape velocity, it's just this infinite path. There's no real resistance now. You're going forward. That doesn't really work with companies. There are always challenges that come up. This is something we have to think about.

Yeah, the Voyager satellite's not coming back to Earth anytime soon, if at all. And these companies can definitely fall down. Now, it is to say that, let's say a company that's achieved escape velocity or, as Tim Sparks, our engineer, said, become Jupiter, Apple has a very small probability of falling back down to Earth, becoming, let's say, a $1 billion market cap, but it isn't impossible. Continuing with the CrowdStrike example, what do you think it's doing differently than its competitors that allows it to achieve that escape velocity potentially? I think that CrowdStrike is very good at focusing on what makes its platform different in the marketplace. They were a pioneer in

this real-time data analysis that could be shared among all points in its system. They find a problem, they isolate it, they extrapolate what's happening, and they can quickly spread the threat prevention all across their network. All users get the benefit of this single isolated incident that they have treated. What you do best is sometimes the thing to keep focusing on, not to get diffuse and try to sell every last service to every possible customer. Focus is really hard for growth companies because management always feels the pressure to deliver that growth. This is one of the things that pulls a lot of subpar management teams off a great game, the inability to be courageous, focus on what

you do best, and get better at it. I think this is one of the things, it's an intangible that's helped CrowdStrike really excel in the marketplace, and has enabled them now to expand the offerings within their platform. Asit Sharma, always a pleasure talking to you. Any final thoughts on Escape Velocity that you think about as an investor before we wrap up? I think the one thing that comes to mind when looking at this concept is, you don't have to have a perfect metaphor if you want to use this in your own investing. Really, the spirit of it is more important than checking off all the boxes. For those of you who are listening and were kids who wanted to get into space but never

made it to NASA, you still have that interest in astronomy, you still follow launches, you're still learning. Nothing has to be the ideal in investing. For this metaphor, the same holds. You're telling me I wasted my time watching the YouTube videos from physics professors Exploiting escape velocity. Appreciate it, Asit. That was time well spent, Ricky. You educated me in the process. That's all for today's show. We're back tomorrow with the radio show. As always, people on the program may have interests in companies they talk about, and The Motley Fool

may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll see you again soon.