Tesla (TSLA) Chief Elon Musk was just granted a new package of stock-option based incentives, detailed in the company's latest 10Q filing, under "CEO Grant."
While these incentives are no doubt interesting to Musk -- given he's the beneficiary -- they are, if anything, more interesting to investors.
The significant features of the package are as follow (full details here):
- On August 13, 2012 (the Effective Date), Musk will be granted an incentive package consisting of options equivalent to 5% of Tesla's stock on issue, with an exercise price equal to the 30 day moving average stock price on the Effective Date (call it $30, even).
- These options will be split into 10 tranches of roughly 510,000 shares each, to be vested based on a combination of operational and market capitalization milestones.
- Considering the market capitalization milestones -- one tranche will become "eligible" for vestment for every $4 billion increase in Tesla's market cap -- from a starting point of its market cap on August 13.
- The 10 operational milestones are linked to successfully delivering alpha, beta, and production versions of the Model X and Gen III vehicles, achieving aggregate vehicle deliveries of 100,000, 200,000, and 300,000, and achieving a gross margin greater than 30% for four consecutive quarters.
There are three possibilities here:
- Musk has accepted targets that he has low expectations of achieving for some other purpose, such as increasing investor confidence.
- Musk is hopelessly optimistic.
- Tesla's realistic growth potential over the next decade is significantly greater than is widely acknowledged.
Musk does not seem the type to shrug off failure in the pursuit of goals -- especially highly visible and explicitly documented goals. While he might accept and even perhaps welcome ambitious goals, I don't think he'd accept goals that he thought were ludicrous. He has his pride, and I don't think he is planning to see a headline like:
Musk Scores Two Out of 10 -- Underperforms, Limits Incentive Package
It's also drawing a long bow to suggest he's hopelessly optimistic. Optimistic, yes -- he wouldn't be a successful entrepreneur otherwise, much less one who has founded automotive and space launch companies. However, his success in both of those fields amply demonstrates that he's not away with the fairies. He can get things done, and hence, must have a pretty good grasp of the associated obstacles.
The implied growth potential is what's left after the first two possibilities are exhausted. I'm inclined to assume a mix of the three possibilities -- I think Musk would accept some goals he thought were unrealistic, and that he's perhaps overconfident regarding others. The remainder are those he is justifiably confident in reaching.
Okay, So What?
To recap: There are 10 tranches, the entire package expires after 10 years, and for each tranche, both an operational and a market capitalization target must be met. The former will drive the latter, obviously, and I think Musk's success rate on the operational targets will be 100%. But that's not enough. 100% on the operational targets earns him nothing unless he also achieves market capitalization targets. This is where the tale becomes interesting for a Tesla investor.
The required market cap increase for each tranche is $4 billion. If Musk is going to vest one tranche per year over the coming 10 years, then Tesla's market cap and share price must do this:
(click image to enlarge)
The reason the market cap increase is linear while the share price increase is not is that I'm allowing for significant dilution of the shares currently issued: 5% per year of the previous year's total for raising additional capital, and 2% per year as internal incentives with a near-zero exercise price (in addition to the 0.5% of the 2012 value received per year by Musk). Thus, these estimates give Tesla the freedom to raise an additional $7 billion through issuing new stock over the period in question; starting with around $300 million in 2013 (or perhaps later this year), and increasing to $1 billion-ish in 2021.
Now, I'm not saying that this is what is going to happen (and even if it does, it will likely be biased either earlier or later). Maybe Musk will only hit 50% of his targets, in which case the appreciation in share price would be half as much (but still pretty spectacular!). The point is that even a 50% hit rate would imply a lot of room for growth in the stock, and I have a suspicion that Tesla isn't expecting this level of growth through simply going head-to-head with Toyota (TM) and GM (GM). Toyota made around 8 million cars in 2010, and its market cap is $120 billion. Does Tesla expect to make 2.5 million cars in 2022 to justify a $40 billion cap? It seems unlikely. I rather predict on the order of 500,000 -- 1 million, but with higher margins and a good growth story. Either way, to achieve such rapid market share growth, and maintain margins, Tesla cannot just aim to be the next Ford.
How Will Tesla Deliver?
Differentiating on vehicles alone will not be enough -- Tesla may make the best electric cars in the world, but the market will become incredibly competitive. The vehicle spec sheet is not the full story however -- Tesla's dealership strategy is significantly different to that of its contemporaries (and heavily criticized, much as Apple's was). Its infrastructure strategy has also started to show hints of "Better Place" (which, in 2010, raised funding from HSBC at a pre-money valuation of more than $1 billion on the back of little more than an idea and prototype).
I increasingly suspect that Tesla's aim is not just to create electric vehicles (EVs), but to create an entire EV ecosystem. An exclusive infrastructure framework in particular could deliver the lasting differentiation necessary to deliver the high margins and high growth that are essential for Musk to chalk up another "mission accomplished." Of course, conventional wisdom would suggest open standards over walled gardens. If you get the package right, however, walls work pretty well. Just ask Apple.
Tesla's stock has had a rough ride of late, and I think the volatility may well continue over the coming two quarters as sentiment swings back and forth. Mid-term, however, I'm inclined to bet on Musk -- he has a history of playing to win, and winning, and I can see the outlines of Tesla's vision clearly enough to be confident that it's not just posturing. It's not a sure thing -- but neither was Apple at $30/share.
The focus today is (rightly) on the Model S, which Tesla must execute well on to gain the strength for the next step, but it can't be the full picture. Musk plainly has something up his sleeve. You think he's signing "X" in this photo? He's just stopping strategy from falling out.
It will be interesting to see what the coming Super-Charger announcement brings.
Disclosure: I am long TSLA.