Tesla: the Threat of Dilution
Stock investors often overlook the risk posed by share dilution.
The concept is simple and at its most basic level can be likened to a pizza: The more you slice a pizza, the less pizza is represented in each slice. Likewise, the earnings, or EPS, represented by each share of a company’s stock decreases when the company issues more stock–all other things being held constant.
Several other factors come into play, including the firm's WACC, IRR and ROIC.
Still, stock issuances aren't always a bad thing.
Often it is a good when a fast growing firm issues more stock as this means the company has more capital to expand and can further increase EPS at an attractive rate. However, in the case of Tesla Motors Inc (TSLA), dilution may mean disaster for investor value.
Here's what is happeningAnalysts are estimating that Tesla will need to raise $12.5 billion by 2018 to fund its expansion and acquisition of SolarCity Corp (SCTY). Obtaining this capital through debt is risky because it adds the weight of higher interest expenses to an already highly-leveraged firm.
Tesla is currently trading at a market cap over half that of General Motors Company (GM) while generating a small fraction of the revenue (really small fraction).
By all measures, Tesla stock is expensive, and issuing equity at this price is a good deal for the company.
How bad will the dilution be?Tesla’s share dilution and quarterly net losses had a deleterious effect EPS over the last two years. EPS is now at -$6.93 from -$1.50 in 2014. It is likely this trend will intensify as the firm acquires a non-profitable SolarCity and continues to offer employees huge amounts of stock-based compensation packages.
Tesla will need to issue a great deal of new equity to meet its capital requirements for the next few years. This will add to the firm’s total share count which currently sits at almost 150 million.
To put the problem in perspective consider this: Tesla needs $12.5 billion by 2018 and would have to issue over 30 million shares to raise just half of that amount.
What would this do to its already low EPS? Add dilution to the long list of reasons why investors should avoid Tesla stock.