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Technology entrepreneur Elon Musk arrives the Tesla Gigafactory construction site for a visit in Gruenheide near Berlin, Germany (AP)
Technology entrepreneur Elon Musk arrives the Tesla Gigafactory construction site for a visit in Gruenheide near Berlin, Germany (AP)

Elon Musk’s payday could cost Tesla shareholders dearly

The accounting effect of options awards for Tesla’s CEO could push it into a loss and disqualify the company from S&P 500 index inclusion for a long time

Thanks to Tesla’s meteoric share-price rise, Elon Musk is set to cash in on a huge bonus package. Shareholders counting on their own tidy fortunes should know how Mr. Musk’s payday might dent their prospects. The inclusion of Tesla in the benchmark S&P 500 index could face a further major delay because of the accounting impact.

In 2018, Tesla awarded Mr. Musk a pay package which includes stock options for more than 20 million shares that vest in 12 tranches, based on a combination of operational and market-value milestones. On a postsplit basis, those options can convert into 100 million shares. The first such tranche paid out in May as Tesla reached and sustained $100 billion in market value, according to a securities filing. The company awarded Mr. Musk shares worth nearly $800 million at the time. Tesla stock has doubled since then, and it is highly likely that other tranches will vest this quarter, which would net Mr. Musk billions more.

However Tesla decides to treat that in its pro forma results, those option grants need to be expensed according to generally accepted accounting principles. That is the standard the index-inclusion committee uses.

Tesla had recognized some of these expenses ahead of time as the milestones came into sight. For instance, the company recorded an expense of $72 million in the fourth quarter of 2019. Tesla recorded $347 million in stock-based compensation expense in the most recent quarter, which was an increase from past periods but still low enough for the company to churn out a profit according to GAAP.

Tesla said in February that “the achievement of a market capitalization milestone earlier than expected may accelerate the rate" at which compensation expense is recognized. Any expenses not already booked are recognized as a tranche vests, the filing says. Back then, Tesla’s market value was $145 billion. As of Thursday, its market value was around $350 billion, having reached as high as $463 billion in August.

That new expense threatens to put Tesla’s streak of four consecutive quarters of GAAP profits in jeopardy. Over those four quarters, Tesla has averaged quarterly net profit of about $70 million.

The fresh costs won’t affect Tesla’s cash balance, which was further boosted by $5 billion following last week’s capital increase. But they could harm Tesla’s chances of index inclusion, which was widely anticipated but failed to materialize last week. While the selection committee could opt to include a new company at any time and make exceptions to its rules, the rules call for a GAAP profit in the most recent quarter and cumulative profitability over the previous four. A third-quarter net loss of just $226 million would put Tesla in the red over the past four quarters. Given the size of the options awards and the recent gains in Tesla’s share price, a billion-dollar quarterly compensation expense is within the realm of possibility.

That presents a big risk for shareholders. Tesla stock fell 20% in the first trading session after the committee rebalanced the index without including Tesla. They probably would fall more if people think that index inclusion faces more than a speed bump. If it causes a serious delay, Mr. Musk’s recent payout will quite literally come at other shareholders’ expense.

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