The Ferrari IPO: A Price Premium For The Prancing Horse? by Aswath Damodaran, Musings On Markets
I live in a prosperous suburb, sustained largely by financial service businesses, but as far I know, there is only one Ferrari in my town. Much of the week, the car sits in a garage which has its own security system, more secure than the one protecting its owner’s house, and on a nice weekend, you see the owner drive it around town. It is a remarkably inefficient transportation mode, too fast for suburban roads, too expensive to be parked at a grocery story or pharmacy, and too cramped for car pool. All of this comes to mind, for two reasons. The first is the imminent initial public offering of the company, with all the pomp and circumstance that surrounds a high-profile offering. The second is that this offering has set in motion the usual talk of brand names and the price premiums that we should pay to partake for investing in them.
Ferrari: A Short History and Background
The Ferrari story started with Enzo Ferrari, a racing car enthusiast, starting Scuderia Ferrari in 1929, to assist and sponsor race car drivers driving Alfa Romeos. While Enzo manufactured his first racing car (Tipo 815) in 1940, Ferrari as a car making company was founded in 1947, with its manufacturing facilities in Maranello in Italy. For much of its early existence, it was privately owned by the Ferrari family, though it is said that Enzo viewed it primarily as a racing car company that happened to sell cars to the public. In the mid-1960s, in financial trouble, Enzo Ferrari sold a 50% stake in the company to Fiat. That holding was subsequently increased to 90% in 1988 (with the Ferrari family retaining the remaining 10%). Since then, the company has been a small, albeit a very profitable, piece of Fiat (and FCA).
The company acquired its legendary status on the race tracks, and holds the record for most wins (221) in Formula 1 races in history. Reflecting this history, Ferrari still generates revenues from Formula 1 racing, with its share amounting to $67 million in 2014. Much as this may pain car enthusiasts everywhere, some of Ferrari’s standing comes from its connection to celebrities. From Thor Batista to Justin Bieber to Kylie Jenner, the Ferrari has been an instrument of misbehavior for wealthy celebrities all over the world.
The Auto Business
In earlier posts, where I valued Tesla, GM and Volkswagen, I argued that the auto business bore the characteristics of a bad business, where companies collectively earn less than their cost of capital and most companies destroy value. In fact, I used the words of Sergio Marchionne, CEO of Fiat Chrysler (and the parent company to Ferrari) to make the case that the top managers at auto companies were delusional in their belief that the business would magically turn around. Looking at the business broadly, here are three characteristics that reveal themselves:
1. It is a low growth business: The auto business is a cyclical one, with ups and downs that reflect economic cycles, but even allowing for this cyclicality, the business is a mature one. That is reflected in the growth rate in revenues at auto companies.
|Year||Revenues ($)||% Growth Rate|
During this period, the emerging market economies in Asia and Latin America provided a significant boost to sales, but even with that boost, the compounded annual growth rate in aggregate revenues at auto companies between 2005 and 2014 was only 5.63%.
2. With poor profit margins: A key point that Mr. Marchionne made about the auto business is that operating margins of companies in this business were much too slim, given their cost structures. To illustrate this point (and to set up my valuation of Ferrari), I computed the pre-tax operating margins of all auto companies globally, with market capitalizations exceeding $1 billion, and the graph below summarizes my findings.
3. And high reinvestment needs: The auto business has always required significant investments in plant and equipment, but in recent years, the advent of technology has also pushed up R&D spending at auto companies. One measure of the drag this puts on cash flows is to look at net capital expenditures (capital expenditures in excess of depreciation) and R&D, as a percent of sales, for the entire sector:
It is this combination of anemic revenue growth, slim margins and increasing reinvestment that is squeezing the value out of the auto business. (You can download the data for all auto companies, with profitability measures and pricing ratios by clicking here.)
The Super Luxury Automobile Business
If, as has been said before, the only difference between the rich and the rest of us is that the rich have more money, the difference between the rich and the super rich is that super rich have so much money that they have stopped counting. The super luxury car manufacturers (Ferrari, Aston Martin, Lamborghini, Bugatti etc.), with prices in the nose bleed segment, cater to the super rich, and have seen sales grow faster than the rest of the auto industry. Much of the additional growth coming from newly minted rich people in emerging markets, in general, and China, in particular. Like the rest of the companies in the super luxury segment, Ferrari is less auto company and more status symbol, and draws its allure from four key characteristics:
- Styling: I am not a car lover, but even I can recognize that a Ferrari is a work of art. That is not accidental, since the company spends substantial amounts on styling and the little details that go into every Ferrari.
- Speed: There is no absolutely no chance that you will test the upper limits of the car’s engine capacity, but you could get from LA to San Francisco in about 3 hours, if you could maintain the car at its top speed (I am not recommending this). So, if you grew up with dreams of being a Formula 1 driver, and now have the money to fulfill them, a Ferrari is probably as close as you are going to get to these dreams.
- Story: The car comes with a story that draws as much from its celebrity connections as it does from its speed exploits.
- Scarcity: Notwithstanding the first three points, it would be just another luxury car if everyone had one. So, it has to be kept scarce to command the prices that it does, both as a new car and in its used versions.
To illustrate how exclusive the Ferrari club is, in all of 2014, the company sold only 7255 cars, a number that has barely budged over the last five years. (The Lamborghini club is even more exclusive, with only 2000 cars sold annually.) The company has its roots in Italy but is dependent on a super- rich clientele globally for its sales:
Note that a significant slice of the revenue pie comes the Middle East and that Ferrari, like many other global companies,