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In my previous article on Tesla (TSLA) I suggested that the company will have to raise more equity in order to grow fast enough to satisfy their investors, i.e. keep the stock price moving up, while the P/E ratio gradually comes down to a more realistic level. Now I will talk about a major dilution that has already happened, but went unnoticed by most investors.

At the beginning of this year, Tesla had 25 million stock options outstanding with an average exercise price of $21.20. By the end of this year at least 11.2 million of these options will be exercisable as Tesla produced its 10,000th Model S vehicle - a performance target linked to 1 million options.

The highest exercise price on all of these options is $36.01, compared to the current market price of $180 per share. We may safely assume that all of these options will be exercised unless the stock goes down 80 percent.

It should be noted that approximately 5.2 million stock options are linked to future performance targets (pages 118-119), including the development and production of Model X and Gen III vehicles. The highest bar that has to be cleared to claim the last 10 percent of the reward? Manufacturing 300,000 vehicles over the next 10 years combined.

If you believe that these targets will be met, you should add 25 million shares to 121.4 million already outstanding as of June 30, 2013.

This means a significant 17 percent dilution for existing shareholders. And what will the company (i.e. existing shareholders) get in return? Not much. The combined value of all outstanding options is $4.5 billion at the current market price. When these options are exercised, however, the company will get only $530 million. The remaining $4 billion will be pocketed by Tesla's directors, employees and consultants, including at least $1.9 billion that will go to Elon Musk. If Tesla's share price goes up, as its investors hope it will, the windfall to Mr. Musk and other directors and employees will be even bigger, while the company gets the same $530 million.

This also means that Tesla's current market cap of $22 billion is correct only from the accounting perspective. A higher number - $26.4 billion at fully diluted 148.4 million shares - should be used for analytical and valuation purposes.

In order to complete the picture, I have to mention 2,018,765 shares reserved for the Employee Stock Purchase Plan (ESPP), which allows employees to purchase shares at 85 percent of "the lower of the fair market value of our common stock on the first and last trading days of each six-month offering period". This discount equals at least $27 per share at the current share price (much more for the current period as the price kept going up), or at least $54.5 million in total. This subtle "the lower of", by the way, creates a great risk-free arbitrage opportunity for Tesla employees. It is very likely that employees will take full advantage of this program. If they do, the company will net up to $309 million at the current share price. It is also a dilution, but on much better terms for the current shareholders.

Taking the additional 27 million stocks into consideration makes it even more difficult to come up with a realistic model that justifies the current share price. While it won't stop Tesla investors from dreaming big, they should remember that at least 18 percent of their dream is already spoken for.

Source: Tesla Motors: Adding $4.5 Billion To Valuation