Recently, the inclusion of Elon Musk operated Tesla Inc. was eliminated in the S&P 500 index. This one single announcement lead to catastrophic reactions in Musk’s net worth as well as the market capitalization of the company. The move caused a barrier in the all high rising shares of the electronic car maker.
Last week, Musk’s net worth dropped $16.3 billion making it the largest single-day plunge ever recorded in the history of the Bloomberg Billionaires Index while Tesla Inc. shares dropped to a shocking record of 20%.
The inclusion or exclusion of firms in the index is determined by S&P Dow Jones Indices. On Friday, it said that technology firm Teradyne Inc., online marketplace Etsy Inc. as well as pharmaceutical company Catalent Inc. will be included in the index as a part of its quarterly rebalancing. Tesla’s inclusion, which was apparently absent in the declaration, was highly anticipated by the market analysts and observers. The senior index analyst, Howard Silverblatt, at S&P Dow Jones Indices declined to comment on the reasons for Tesla’s absence in S&P 500.
Despite experiencing a depressive drop of 34% in September, the stock nearly quadrupled in 2020, a year of humungous challenges for all companies around the world. Tesla has dominated the recovery of struggling Wall Street from the coronavirus induced market crash. The company’s market value has jumped up to as high as $308 billion, making it one of the biggest US companies by that metric.
After the announcement, a regressive attitude of bullish investors was seen, who had earlier aggressively positioned themselves for the company’s addition to the list, especially after its latest quarterly results and plans to split its stock. Investors were blindly bidding on Tesla’s inclusion because as per the conventional methods, a company must secure accumulated profits over four consecutive quarters, including the most recent in order to be a part of the index, which the company has very well reported.
However, there’s more to this than just a mathematical equation comparing revenues and expenses. The methodology starts with being based in the United States and listed on a major American Exchange. The makeup is also influenced by the discretion of the committee which holds the powers to revise strategies to include as well as exclude companies. It is crucial for any company to be listed in the S&P 500 because usually on joining the index companies witness a boost. This is on account of more than $11 trillion in investments tracking the index ultimately causing a jump in buying activity of the stock.
Why was it not included despite high profits?
After conducting a contrasting analysis, market souvenirs pointed out certain causes that held back the company’s listing. A few major factors among the highlighted ones were its profitability metrics and sales of regulatory credits to other automakers. According to its financial statements, over the past four quarters, the electric car maker has made more than $1 billion from such regulatory credits which account for more than two times its profits reported during the same period. In other words, the quality of earnings could be one major reason for its exclusion. Tesla reported revenue of $428 million from the sale of emissions credits in the most recent quarter, along with a net income of $104 million.
What is shocking to note here is that Tesla, if it had been a part of the index, would be the biggest one to join it, with its worth more than nine times the combined value of the other three firms which made it to the list instead.
Taking the discussion to present and future view, another problem that may prevail in getting the company onboard on S&P 500 is Elon Musk’s payout. After an astounding rise in Tesla’s share price, Musk is all geared up to withdraw a huge bonus package. After this, as per analysts, the inclusion of the automaker in the benchmark S&P 500 index could be further delayed on account of the accounting impact.
If we have a look at the past records, Elon Musk was blessed with a pay package that included stock options for more than 20 million shares that vest in 12 tranches. This payout is based on a combination of operational and market-value milestones achieved by the firm under his leadership. According to security filing, the first such tranche was paid out in the month of May. This was at a time when Tesla reached $100 billion in market value. As a token of appreciation, Mr. Musk was awarded shares worth $800 million. Since then its stock has doubled and it is highly likely that other tranches will be vested this quarter. However, as per the standards used by the index inclusion committee, it would have to treat such expenses in its pro forma results. This means that such option grants need to be penned down as per the generally accepted accounting principles.
A few of such expenses had already been recognized, quite ahead of time, as the milestones came into sight. For example, it showed an expense of $72 million in the fourth quarter of 2019. In the most recent quarter, it also recorded $347 million in stock-based compensation expense. Any expenses not already booked are recognized as tranche vests. To put together the impact, back then, Tesla’s market value was $145 billion which jumped to an astonishing high of $350 billion on Thursday, after recording a high of $463 billion in August 2020.
That new expense has the capability to jeopardize Tesla’s streak of four consecutive quarters of GAAP profits, in which, Tesla has averaged a quarterly net profit of approximately $70 million.
The company’s cash balance was further boosted by $5 billion following the recent capital increase and will potentially remain unaffected with these fresh costs. But at the same time, it could deteriorate its chances of being a part of the S&P 500 index anytime soon. Even though the selection committee can decide to include any new name in the gauge at any time, it is mandatory to have GAAP profits in the most recent quarter as well as cumulative profitability over the previous four quarters. A net loss of just $226 million in the third quarter would put the company is the blacklist for inclusion.
This presents a huge challenge or risk for shareholders, especially after its stock plunged 20% in the very first trading session after the committee missed out on Tesla. It is expected that the stock probably would slip down a greater slope if people think that index inclusion is once again troubled.
If it causes a serious delay, Mr. Musk’s recent payout will quite literally come at other shareholders’ expense.