Dem 51
image description
GOP 49
image description

Of Tulips and Truths

In the 1630s, a single mutant tulip in the Netherlands sold for 14x what a skilled craftsman could earn in a year. This speculative bubble was known as Tulipmania. It lasted as long as buyers believed no matter what they paid for a tulip, there would always be a greater fool to whom they could sell it for more than they paid for it. Until February 1637, when the whole scheme suddenly collapsed and the rare tulips were suddenly worth no more than common tulips.

Donald Trump must have heard about that years ago and thought he could try to do it again, only without tulips this time. In 2020, former contestants on Trump's reality TV show, Andy Litinsky and Wes Moss, came to Trump with an idea. They would create a SPAC (Special Purpose Acquisition Company) called DWAC (Digital World Acquisition Company), and get investors to buy shares in it. Then they would merge it with TMTG (Trump Media and Technology Group), the company that owns Trump's boutique social media platform Truth Social. The terms of the merger would be very favorable to Trump. He was interested. This plan violated the rules for SPACs and got the SEC on their case but eventually Litinsky and Moss calmed the SEC. Later they sued Trump because he cheated them out of stock they were entitled to. Surprise.

Early on, 400,000 ordinary investors, basically Trump supporters who knew nothing about tulips or stocks, put up a total of $300 million to buy stock in DWAC. That comes out to an average investment of $750 per investor. Support Trump and make money doing so! Heaven on earth. How many shares would Jesus buy? The DWAC stock went public on the NASDAQ on Sept. 27, 2021 and closed at $9.94 that day. Theoretically, the total number of outstanding shares (37 million) times the share price should be about $300 million because the company's only asset (its bank account) was worth $300 million. By Feb. 28, 2022, the share price had jumped to $97.54, not due to any change in the fundamentals or underlying assets, but because, well, tulips. On Friday DWAC closed at $36.94. Yahoo Finance rates the DWAC stock as hugely overvalued.

The deal is extremely complicated, but here is a rough summary. On Friday, DWAC merged with Trump Media and Technology Group (TMTG), whose only asset is Truth Social, a company that for the first 9 months of 2023 had revenues of $3.4 million but lost $49 million (but much of that loss was interest payments, not an operational burn). So the deal merged two companies: DWAC, whose assets were worth $300 million but whose stock was trading Friday at a price that made the company worth $1.38 billion and TMTG, which owned a company that was losing around $65 million a year with no prospect of ever being profitable. The terms of the deal gave Donald Trump 58.1% of the shares of the merged company, even though the part he brought to the table (TMTG) was worth basically nothing. In effect, he took over DWAC and its $300 million piggy bank by offering his money-losing social media app. This deal will allow him to run Truth Social for years, no matter how much money it loses every year.

Now here's the thing. The folks doing the merger have assumed that replacing the 37 million shares of DWAC with about 128 million shares of the new company won't affect the stock price because (ideally) the investors in DWAC knew the deal was in the works (although the stock dropped 14% on Friday when the deal was consummated). If the current price holds when the new stock begins trading, the company will be worth $4.7 billion on paper. However, this is almost 16x the book value of $300 million. When investors discover this, some of them might get cold feet and sell. If enough do, the stock could drop appreciably early on. The 16x premium over book value might make sense for a company that had just patented a drug that cures cancer or invented an iPhone battery that holds 30 days' worth of charge. Truth Social does not have that kind of potential. Whether the stock price can hold when trading begins remains to be seen considering the merged company has admitted it won't be making a profit for years, if ever.

The merger plan awarded Donald Trump 79 million shares in the merged company. If the $36.94 price holds, his portion of the stock will be worth close to $3 billion. Not bad for a guy whose contribution to the new company is a social media app that is losing money hand over fist. The scam here is that the stock may trade at a value far above what economics says it should trade at. You can check the stock price at Yahoo Finance tomorrow by typing DJT (the ticker symbol) in the search box when trading starts.

The terms of the merger prevent Trump from selling the stock for 6 months without permission of the board. He also can't encumber it or use it as collateral for a loan or bond. However, the friendly board, with Donald Trump Jr. and six cronies on it, could give him a waiver if he asked, which he probably will. However, a waiver could generate a lawsuit since that is not in the interest of the other shareholders.

Another problem is that if Trump tried to sell a large block of stock, word will get out that he is dumping it, which will cause the stock to go into freefall since the company's only hard asset is the cash. Once word is out that Trump has no faith in the company, there could be a bloodbath, to use a word Trump seems to like. Trump might even try to plunder the cash, for example, by using $100 million of the cash to pay out a dividend to all shareholders, of which he would get $58.1 million. The whole idea of the company being worth $4.7 billion is beyond incredible, but believers believe. The only question is whether Trump can dump the stock secretly before the entire house of cards collapses around him, leaving the other shareholders holding the bag. This wouldn't be the first time.

One other point here. Even if Trump got permission from the board to pledge his stock as collateral for his $454 million bond, Trump's problem won't disappear. J.P. Morgan Chase and Chubb don't take chances and will be concerned about liquidity and volatility. They are not going to be fooled by some crazy valuation. They know the whole company is not worth anywhere near $4.7 billion. The CEOs wouldn't get fired for missing predicted earnings by a couple of million dollars, but could be for a big loss on an improperly collateralized bond. All potential surety firms know that Trump could try to withdraw millions at any moment for a dividend or to pay his lawyers, so we suspect it may be tough to use the stock as collateral, even if the board approves it.

On Friday, Trump said that he wouldn't use his windfall to pay for the bond. We think this is probably true, but because underwriters have already told him they consider it too risky.

One final note here is worth tossing out. If Letitia James begins seizure shortly, she could seize his stock in the merged company and announce that she plans to sell it. That would not only drive the price down, but it would also drive Trump up the wall. Since the state of New York would then be the majority shareholder, she could fire the board and install her own board. Her new board could then fire the CEO and hire a new one who believed strongly that social media companies have a responsibility to remove all lies posted to their platform. They could hire someone with the title "Lie Detector in Chief." Then not only would Trump lose the $3 billion he was expecting, but he would also lose the platform he is using to spew all his lies. He could then put his tail between his legs and crawl back to Elon Musk, but that would make Musk the dominant one in the relationship, something Trump would hate. Could James squeeze $454 million out of the stock? Maybe yes, maybe no, but the $300 million in cash would be a good head start.

Thanks to B.N. for the help on the high finance. (V)

This item appeared on Read it Monday through Friday for political and election news, Saturday for answers to reader's questions, and Sunday for letters from readers.                     State polls                     All Senate candidates