Why Hindenburg Research Is Shorting Twitter: 'Musk Holds All The Cards'

Twitter Inc TWTR shares traded lower by 4% on Monday, well off the $54.20 per-share buyout price Tesla Inc TSLA CEO Elon Musk has agreed to pay to take Twitter private.

In a new report, short seller Hindenburg Research said there's plenty of reason for investors to be skeptical of the Musk buyout.

Changing Circumstances: Hindenburg said there are several factors that suggest Musk is not getting the value for Twitter that he was on April 14 when he announced his offer.

Since that time, the Nasdaq has fallen more than 17.6% as a sharp sell-off in tech stocks has accelerated. Meanwhile, Twitter reported weak first-quarter results and disclosed it had overstated its user count just three days after accepting Musk's offer.

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Hindenburg said it suspects Twitter continues to overstate its actual user numbers.

"As indicated by Musk, the platform is flooded with bots, spam, and scam accounts that likely inflate its genuine user metrics even further," the firm said.

If Musk does not complete the takeover, he has explicitly said he will sell his 9.2% stake in Twitter, a massive selling event that Hindenburg said would apply tremendous downward pressure on Twitter's stock price.

Musk's Leverage: Meanwhile, the only potential penalty for Musk deciding to walk away from the deal is a $1-billion breakup fee, which Hindenburg said gives Musk tremendous leverage to try to negotiate a better buyout price.

In addition to being another distraction for Musk, Hindenburg said the Twitter deal has been placing unnecessary pressure on Tesla's stock price as well. Musk has already sold $8.4 billion in Tesla shares to try to raise capital for the Twitter takeover, and Tesla shares are down more than 20% since the buyout was announced.

"Note that Musk previously pledged about 88.3 million Tesla shares as collateral for loans, according to Tesla’s filings prior to the Twitter bid," Hindenburg wrote.

"Placing both Twitter (and ultimately Tesla’s) future on a foundation of further equity-backed margin loans, or potentially more sales of Tesla equity amidst a volatile market, adds risk to both enterprises."

Hindenburg said Musk holds all the cards in the current situation, and the Twitter board would likely do the right thing in accepting a lower buyout price when faced with the possibility of a sharp crash in Twitter shares if Musk called off the deal completely.

"As a result of these developments, we believe that if Elon Musk’s bid for Twitter disappeared tomorrow, Twitter’s equity would fall by 50% from current levels," Hindenburg said.

Benzinga's Take: The fact that Twitter shares are trading at around $48 when Musk's buyout offer is priced at $54.20 suggests there is a significant amount of skepticism that the deal will close at $54.20.

Hindenburg sees a compelling risk-reward opportunity in its short position in Twitter given potential upside in the stock is theoretically capped at $54.20.