A tale of expensive debt: Here’s why this social media giant is seeing its valuation drop massively…

Wednesday: The Independent Investor

FROM THE DESK OF MILES EVERSON: Hello! Welcome to “The Independent Investor!” Every Wednesday, we bring you articles about investing because we believe diving into this activity can help you attain wealth creation and achieve true financial freedom. Today, we’re thrilled to share with you another facet of investing that lots of great investors pay attention to. Continue reading to know how debt and interest rates can heavily influence a company’s valuation. CEO, MBO Partners Chairman of the Advisory Board, The I Institute

A tale of expensive debt: Here’s why this social media giant is seeing its valuation drop massively… High interest rates and fear around debt have played a big part in spooking investors. From private equity to venture capital, high financing costs have led to massive dips in company valuation as corporate debts pile up. Take social media giant X (formerly known as Twitter) for example. Ever since the social media behemoth was acquired by Elon Musk in late 2022, X’s valuation started to tank. X struggled to bring in profits, leading Musk to cut the company’s workforce in half to save costs. However, this move wasn’t enough to offset the loss of advertising revenue. Within the first month of Musk’s acquisition, big corporations like Eli Lilly, General Motors, and General Mills, stopped buying ads on X. Near the end of 2023, names like Walmart, Disney, and IBM followed suit and left the platform as well. To make things worse, X’s valuation dropped to USD 19 billion in the same year, less than that of Musk’s original purchasing price. Unfortunately for Musk and the social media giant, the drop in the firm’s valuation has continued. In today’s “The Independent Investor,” we will take a look at X and how its situation represents the current corporate credit environment. X’s True Valuation Pinpointing X’s valuation has been difficult ever since Musk took it private. However, a peek into the company’s valuation is made possible, thanks to investment firm Fidelity. You see, Musk was able to fund his multi-billion dollar acquisition of X with debt from several banks and a small equity stake from Fidelity’s Fidelity Blue Chip Growth Fund (FBGRX)—a mutual fund that invests around 80% of its assets in blue-chip companies. Since FBGRX is a mutual fund, everyday investors can see whenever the value of Fidelity’s position in X changes. Ever since Musk’s acquisition, the fund has marked the value of its position down to 73%. Meanwhile, it has not reported any changes in its position size so far. This means it’s the value of X that is dropping. Musk may have a lot to do with this drop, since he was the one who drove several big advertisers off the platform. Yet, there’s more to this than meets the eye. When Musk took X private, he funded the deal with USD 13 billion of debt before interest rates soared to scorching highs. Unfortunately, most of this is “floating rate,” which means that as interest rates rise, the cost of financing the debt will increase. When the deal to acquire X was acquired, the Secured Overnight Financing Rate (SOFR) was extremely cheap at 0.3%. Since then, it has risen to about 5.3%. That’s not all. The most expensive part of the deal involved loans that at the time of the acquisition, carried a 10% interest rate plus SOFR. Fast forward to the present, several banks—including Morgan Stanley—that helped fund X’s acquisition are trying to get rid of their exposure as fast as possible. In particular, Morgan Stanley said that in 2022, the loan it gave in the acquisition of X partly contributed to its USD 867 million loss on loans held for sale. Just like other firms, X had an extremely high valuation because debt was so cheap back then. Now, its valuation is falling back down as debt piles up. High interest rates and rising fear around debt have played a large part in X’s troubles. The same can be said for plenty of other companies today. So, the next time you scour the market for opportunities, make sure to take debt and interest rates into account! These factors can significantly affect company valuations, the stock market, and your investment portfolio as a whole. Hope you’ve found this week’s insights interesting and helpful.     Paul Henry O’Neill was an American businessman and government official who served as the 72nd U.S. Secretary of the Treasury for part of former President George W. Bush’s first term. Learn more about this person’s unconventional strategy of “annoying” Wall Street in next week’s article!