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Fiat Chrysler’s (“Fiat”) decision to IPO 10% of Ferrari’s capital with the balance to be distributed to Fiat’s existing shareholders in early 2016 appears clever from Fiat’s point of view. As part of the spin off, Ferrari is paying €2.8bn to Fiat via the FCA loan note (due April 2016). This significantly mortgages Ferrari relative to its balance sheet (net assets €2.46bn 31 March 2015) and in the circumstances of a growth slowdown.
The Ferrari business is well known to Fiat, it originally bought 50% of Ferrari in 1969. Fiat has a considerable advantage over investors in its understanding of Ferrari. Fiat is in the midst of a €45bn investment programme hence has significant capital needs in respect of Ferrari. It is also rated BB- a non-investment grade reflecting Fiat’s weak balance sheet and capital requirements.
The Ferrari IPO at $52 per share ($9.8bn market capitalisation/ $12.3bn including debt) has attracted significant retail and institutional interest despite the current upheaval in the automobile sector (post the Volkswagen scandal). The IPO was oversubscribed and UBS has already exercised its over-allotment option over 1% of the shares. The valuation of Ferrari has raised eyebrows as it appears expensive relative to its peer group and likely growth prospects.
Whilst this is a rough and ready measure, on the basis of Ferrari’s 2014 net profit of €265m ($300m) the IPO values Ferrari on a P/E of 32.6x. This is expensive relative to auto peers (Daimler 10.4x, General Motors 12.9x, Ford 16.8x, Porsche 4.4x and Tesla Motors Inc 27.1x). Furthermore the rating suggests high profit growth which at Ferrari is limited to cost efficiencies and price uplift.
The problem is Ferrari’s expected production growth. This reflects the fundamentals of the luxury car market and the need to preserve high prices by not rapidly increasing production (which necessitates lower prices). Typically Ferrari establishes a volume target and then manages waiting lists in respect of the target. Relatively static production leaves the company with only cost efficiencies and pricing as levers for managing profit.
Source: Ferrari IPO prospectus
Over the next 4 years the Ferrari board are targeting unit growth of 4.4% pa to 9,000 by 2019. This is relatively pedestrian, the nearest peer group company on a similar P/E rating, Tesla Motors (2015 50k units forecast) is expecting to increase production to over 100k by 2019. Ferrari manufactures at its home in Maranello. Even if the board were to change its volume based system, the issue would be how to ramp up production using existing facilities. We suspect higher production would require significantly higher capital spending.
Part of the Ferrari allure is its enduring global appeal in the premium sports car segment. This is due to Ferrari’s ability to maintain its super car program which began in 1988 with the F40 – now the main models are the 458 Italia, F12 berlinetta, FF and California. For 2015 the plan is to turbocharge all future V8 models starting with the California (its least expensive model at $202k) in 2015.
There is a significant expertise at Ferrari in car engine design/ technology and brand/ licensing opportunities. Ferrari manufactures engines for Maserati (2014: 36,500 units sold +136% on 2013) an area of significant growth. In addition to merchandising lines, eyewear, pens, pencils, perfume, clothing, bicycles, watches, mobile phones using the Ferrari brand. The merchandising are useful adds-on but not the core business.
Whilst we recognise the significant brand value at Ferrari, (the major reason for the premium Ferrari valuation) making an investment in Ferrari stock or indeed any other recognisable brand on this basis alone has had mixed results. One recalls the high profile global brands of the 1990’s, companies like Apple, Merrill Lynch, Nike, McDonalds, Vodafone. Our suggestion is a brand is a great asset, but investors should not invest solely on this basis.
Fiat will hold an EGM on December 3rd 2015 to approve the de-merger of its 80% stake in Ferrari to Fiat shareholders. This is a de-merger of a very high proportion of the Ferrari capital and likely to be the main driver of the Ferrari share price.
This transaction will increase the free float from 10% to 90% (Piero Ferrari holds the balance 10%) hence removing pricing anomalies caused by the low float in the NYSE IPO by early 2016. Hence the next few months will be a fast moving sequence of events as Fiat holders anticipate and possibly hedge against their forthcoming Ferrari distribution. Nearer to the de-merger date (as yet undecided) it is likely that Fiat shares will reflect the forthcoming de-merger possibly presenting a cheap way into Ferrari via Fiat. It will certainly represent an alternative way to buy exposure to Ferrari.
One perceived reason for the IPO is to create investor interest ahead of the distribution to “whet investor appetite”. It has certainly achieved that objective with the shares holding onto a 6% premium despite the top of the range pricing. The initial range was $48-$52.
We are sitting on the fence at the moment, recognising the brand value, but weary of the high Ferrari valuation and forthcoming events. It is likely that investors will be able to pick up the shares post the distribution in an environment of a high free float, rather than the rather artificial tight conditions at the moment.
Ferrari sits perfectly within our HOLD criteria with potential investors advised to await key events notably the forthcoming Fiat de-merger of the balance 80% stake.