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Saturday, May 8, 2021

Tesla’s “ hidden ” shareholder risk: executive options, taken to the extreme

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The option compensation plans approved by the board are aggressive, especially for Technoking (formerly CEO) Elon Musk. The Compensation Committee of the Board acts as if granting options based on fundamental growth and market capitalization is a win-win situation for both executive performance and shareholder growth benefits. . Obviously, the stock market performance of the past year has supported this view.

However, heavy option plans cost the shareholders of the company in several ways. The board is supposed to focus on the well-being of shareholders, but keeping Elon happy seems like an important goal.

The three-part damage to shareholders that is “hidden” (AKA ignored)

The first part of the damage is the dilution of the current shareholding

The increase in shares caused by the issuance of options should be taken into account even if the options have not yet been exercised. Tesla’s dilution number is huge and growing:

For the first quarter of 2020, the average number of shares outstanding was 915 million. The addition of the shares represented by the options produces the total “diluted” shares of 994 million, an increase of 79 million equal to a dilution of 8.6% for the then current shareholders.

After one year, shares outstanding in the first quarter of 2021 reached 961 million, an increase of 46 million (+ 5%). Growth in total diluted shares was even greater at 1,133 million, an increase of 139 million (14%). These changes pushed the dilution to 172M, a significant dilution of 17.9% for current shareholders.

The second part of the harm is the misrepresentation of Tesla’s growth

The Wall Street Journal reported, “Tesla posts the highest profit with a 74% increase in sales.” While this is true for overall revenue (compared to Q1 2020), it is not the growth that current shareholders have received. To calculate shareholder growth, total sales must be converted to a number per share, which means dividing by those total diluted share amounts.

  • First quarter 2020: $ 5,985 million in sales divided by 994 million diluted shares = $ 6.02 in sales per share
  • Second quarter 2021: Sales of $ 10,389 million divided by 1,113 million diluted shares = $ 9.17 in sales per share

As a result, shareholders received a sales growth advantage of 52% – one-third less than the company’s 74% total announced.

The third part of the damage is the misrepresentation of earnings

This WSJ article said total profit was $ 438 million, below Wall Street’s average expectation of $ 509 million. However, you’ve probably read that earnings per share was $ 0.93, well above the average estimate of around $ 0.79. So, what gives? “Stock-based compensation” (SBC) is the answer. It is the processing of this expense that is the result of everything Tesla’s option issuance does.

The WSJ’s $ 438 million is the exact amount of profit, but that produces earnings per share (using those total diluted shares) of just $ 0.39 – well below the widely reported figure of $ 0.93.

Note: it’s time to talk about technical accounting. The FASB (the Financial Accounting Standards Board) is responsible for determining the requirements for companies to produce accounting statements in accordance with “GAAP” (that is, in accordance with generally accepted accounting principles). GAAP requires companies to report stock-based compensation as an expense.

For the first quarter of 2021, Tesla’s SBC amount was $ 614 million. However, Tesla also reports, and many on Wall Street use, non-GAAP results. Pages 27-29 of Tesla’s Q1 Update provide a “Reconciliation of GAAP and Non-GAAP Financial Information.” These pages answer the question of income. Starting with actual GAAP profits of $ 438 million, Tesla adds back the large SBC expenses of $ 614 million with an adjustment of $ 5 million, producing a new profit total of $ 1057 million. It is titled “Net income used in the calculation of diluted EPS attributable to common shareholders (non-GAAP)”.

For earnings per share, they start with the GAAP amount of $ 0.39, add back the SBC expense of $ 0.54, producing non-GAAP EPS of $ 0.93.

Note: Many other companies also report non-GAAP earnings with adjustments intended to provide a better overview of their operations. The problem with Tesla’s non-GAAP reporting is that the spending and dilution of their options program is so large that it’s an integral part of how the business is run. Their weak justification for shareholders to focus on non-GAAP numbers can be seen in their “Non-GAAP Financial Information” footnote on page 29, shown here (emphasis mine):

“The consolidated financial information has been presented in accordance with GAAP as well as on a non-GAAP basis to complement our consolidated financial results. These non-GAAP financial measures also facilitate management’s internal comparisons with Tesla’s historical performance as well as comparisons with the results of operations of other companies. Management believes that it is useful to supplement its financial statements in accordance with GAAP with this non-GAAP information, as management uses this information internally for reporting purposes. operations, budgeting and financial planning. Management also believes that the presentation of non-GAAP financial measures provides useful information to our investors about our financial condition and results of operations, so that investors can see through the Tesla’s management eyes the important financial parameters ts that Tesla uses to run the business and give investors a better understanding of Tesla’s performance. Non-GAAP information is not prepared under a comprehensive set of accounting rules and, therefore, should only be read in conjunction with financial information presented under US GAAP when understanding Tesla’s operational performance. .. ”

Put it all together and the shareholder is on the losing side of the Tesla options program

This painting tells the story: diluted ownership, diluted growth, and deceptive profits.

The bottom line: how long will shareholders and Wall Street be prepared to neglect reality?

Popular business leaders gathered things together that persisted even when their history weakened. However, there comes a point when investors move on. For Tesla, that could start this year if competition makes inroads and valuation comparisons make SBC spending an issue.


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