Thursday, AtonRa Partners published an article titled "Tesla: $421 Or $36? Pick Your Scenario". In it, AtonRa describes three sets of assumptions which, when plugged into a DCF, give us three different possible values for Tesla(NASDAQ:TSLA) stock:
- $36 in a bear case;
- $305 in a base case;
- And $421 in a bull case.
Leaving aside the fact that a DCF can produce any value, as so well illustrated here, or that the base case is more akin to a bull case, there's something else which fanned a bit of debate in the comment section. I am talking about dilution.
The implied assumption for dilution as used by AtonRa Partners is that there isn't any. AtonRa uses around 126.8 million shares as the divisor to get his value per share from equity value.
There are a couple of problems with this. The main two are as follows:
- Tesla already has more diluted shares than the ones considered by AtonRa. AtonRa was probably distracted by the fact that when Tesla reports diluted shares, it does not include potential dilution because it's reporting a GAAP loss. At this point, instead of the 126.8 million shares considered by AtonRa, the fully diluted count already stands as high as 140.9 million shares already. The relevant passage in the latest 10-Q describing this is here:
- AtonRa does not consider the ongoing dilution. The following table illustrates the evolution of shares outstanding (ignoring the anti-dilutive effects described in the previous point), and we can see that the number of shares climbs rapidly. This climb, even if it moderates, is very likely to continue. Using just the last 3 years (ignoring the massive jump from 2010 to 2011), we get a CAGR of 7.4% in shares outstanding. Admitting this would slow down to a CAGR of just 3% over the life of AtonRa's DCF, this would give us 189.4 million shares during 2024. This is the number of shares which one ought to use to properly divide the equity value. This would transform the bear, base and bull cases from AtonRa's $36, $305 and $421 to $24, $204 and $282. These would completely transform the conclusion, as even the massive bull case encases very little upside.
AtonRa used the following arguments when defending his dilution assumptions:
- That the strikes on existing options are high and won't get exercised;
- That these are his assumptions and mine are unduly negative.
This defense is questionable
For several reasons, this defense makes no sense. These include:
- Existing diluted shares, counting options with strikes below the market price and restricted units, are already much higher than the assumption used by AtonRa;
- If the share price fell, options with high strike prices would get repriced. This has lots of historical precedent. They call it share-based compensation for a reason;
- Even if the share price fell and options were not repriced, the company continuously awards new stock options, whose strikes take into consideration the existing market price. So there's still dilution anyway;
- And as can be seen from the 10-Q, the company also sometimes awards stock directly, which always dilutes no matter what the share price.
The fact is that at practically any tech company using stock-based compensation and not buying back stock, the dilution is always ongoing and as such you cannot ignore it.
Plus of course, if AtonRa is considering the free cash flow from stock-based compensation, he necessarily has to take into account the dilution resulting from that same stock-based compensation. Though AtonRa is not the first to make this mistake (I remember Morgan Stanley doing the same with Amazon.com), it's still a mistake.
All in all, I believe this was an honest mistake which the author was not willing to address since it would lead to re-writing a great portion of the article. Yet, this is a very obvious mistake which transforms his conclusion.
When doing a DCF, an analyst has amazing latitude to produce any results he wants. Most of the inputs are not observable; they're highly speculative takes on the future. Yet, dilution is one of the most concrete effects you can take into account, and obviously already-existing diluted shares are a certainty. Ignoring these makes no sense.
In short, even AtonRa's extremely optimistic assumptions for TSLA see no upside when corrected by more-than-predictable share dilution.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.