A Piece of Ferrari

Ferrari California T convertible

Ferrari California T

A few weeks ago Fiat Chrysler Automobiles (FCA), majority owner of Ferrari, announced it would spin-off the fabled Italian marque next year by floating 10% of the shares on a stock exchange and distributing another 80% to its shareholders.

While details explaining exactly how FCA will go about doing so have yet to be announced, reports indicate that one would have to buy them on the market or be an existing shareholder. How I understood it is if you want to get your mitts on a piece of Ferrari you will probably do better to buy Fiat Chrysler shares than wait to buy Ferrari shares next year, even if it means having to buy convertible debt.

Why Is Fiat Chrysler Floating Ferrari?

Basically they are borrowing on Ferrari’s good name because FCA needs to raise some $60 billion to fund product development through 2018. Various estimates have pegged Ferrari’s value at around $7 billion while FCA’s entire market cap (including Ferrari) is only about $18 billion. No wonder FCA wants to spin off the Prancing Horse.

Ferrari is worth more standing on its own than under the Fiat Chrysler umbrella. So separating Ferrari will more accurately reflect the value of the brand, increasing the amount against which FCA can borrow for product development.

So early last week I bought some FCA shares (stock ticker FCAU) not only because I’m a Ferrari fan – which is a terrible reason to buy stock – but also because I think it’s a good long term investment (even if I don’t view FCA in the same light). Here’s why.

Ferrari Has Cornered the Exotic Car Market

Ferrari stands head and shoulders above every other exotic car manufacturer and rakes it in because its brand is so powerful. When you think about other companies in that space, who comes to mind?

Maybe a few others such as Porsche, McLaren, Lamborghini, Aston-Martin, Lotus, Bentley, Rolls-Royce? Bentley and Rolls aren’t direct competitors in that they don’t make sports cars. Aston isn’t likely profitable, Lotus is perpetually not. Both seem to be experiencing existential issues.

Porsche and Lamborghini are now both owned by VW. Porsche is highly profitable and Lamborghini likely is. But Porsche has grown into a mass market company with a range of vehicles including two SUVs. It also doesn’t make $400,000 production cars (the limited production 918 Spyder notwithstanding). The Venn diagram of Porsche and Ferrari buyers has even less overlap than it had in years past.

While Lamborghini has produced some fine automobiles and continues to ramp up its volume, it doesn’t command the same level of recognition as the Prancing Horse. It doesn’t quite have the same consistent heritage. On the other hand, though McLaren ranks second only to Ferrari in F1 records and history, the wonder from Woking also does not have the same recognition as those steeds from Maranello. And every other sports car manufacturer is a bit player.

Meanwhile Ferrari limits supply to maintain a high level of demand. Its waiting list for new car buyers stretches for years. There are 37 dealers to sell and service nearly 4,000 new Ferraris each year in the U.S.

With cars retailing for between $190,000 and $400,000, plus service and sales of used cars, the market is not going away any time soon. If anything it’s growing. Yet, with the exception of McLaren’s 2010 launch, it’s not likely another player will materialize with anything approaching the cachet and mystique of Ferrari as the barriers to entry continue to rise.

Formula One Is Just Icing

Sure the company has not been doing well in F1 but I don’t think it’s that big of a deal. As long as they can land a win or two each season things will be fine. While it certainly helps, the company doesn’t have to win regularly to be profitable due to their legendary status as the sport’s only original team.

Moreover, with sports car racing on the ascent and F1 seemingly lurching from one self-inflicted crisis to the next, Ferrari’s racing future may well rest at Le Mans. Ferrari does not need F1. But it does need to race. Somewhere.

Fiat Chrysler Stable Enough to Hold For Now

One time I had a Chrysler PT Cruiser as a rental car. I found it only slightly less objectionable than a Pontiac Aztek, and the engine note sounded distinctly like someone had forced round pistons into cylinders that weren’t quite so.

Speaking of the sum of the parts being worth more than the whole, that rental car was the antithesis of refinement. Which is not surprising considering FCA nameplates ranked 23rd, 25th, 28th and 30th out of 31 in the 2014 J.D. Power Vehicle Dependability Study (VDS) – about where they often rank.

While leasing has grown to about one-third of the new car market, have you ever noticed Chrysler nameplates seem not to offer that option? There’s a reason for that (hint: resale value). FCA is one of the last places I would put money in the long term.

However, Chrysler just had its best October sales in years. It also has the lowest fleet average fuel economy in the U.S. With oil prices dipping (for now) to the lowest levels since 2012 and American consumers’ collective fuel price amnesia, Chrysler potentially stands to benefit even more from this temporary circumstance than other manufacturers by selling more profitable vehicles with lower fuel economy (300 sedan, RAM pickup, Jeep anything, etc.).

These circumstances will somewhat temper the shock should a calamity arise before the Ferrari spin-off and hammer the FCA share price. But for now lower fuel prices are likely to remain a reality. So despite my view on FCA I’m in.

Risks of the Prancing Horse Becoming A Donkey

One major downside of going public for Ferrari is if it capitulates to shareholder pressure (e.g. from activist investors) to crank up sales and licensing revenues, it could damage the brand in the long term. People with influence who don’t understand the unique business it is might be tempted to steer the company down a path toward overcapacity or making inauthentic products, like an SUV or minicar (I’m looking at you Aston-Martin). This would be far worse than not winning or racing in F1.

Another risk, like with any other carmaker, came to light when Ferrari recently got a slap on the wrist and paid a $3.5m civil penalty to the National Highway Traffic Safety Administration (NHTSA) over a failure to submit Early Warning Reports of potential or actual safety issues. As tragic as several fatal accidents may have been, we’ve seen far worse from practically every other carmaker. In business terms, it’s not a serious setback. The settlement is a blip on the financial radar.

Lastly, it comes down to a matter of share price. Will FCA and the market accurately account for Ferrari’s preeminent position when it comes time to spin-off the Ferrari shares? No one knows for sure.

But overall I think the risks are mild enough in light of the other points above, and the road long enough, that I am willing to wager a modest sum on this thoroughbred in the supercar stakes race.

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