Ferrari – inspiring cars, so-so IPO

There is certainly something special about a Ferrari (NYSE: RACE) . Although I've never owned one myself I've been a long-time addict of the the Alfa Romeo Spider which might be considered a "poor man's Ferrari." I do get the appeal of the car. My mechanic always has a few Ferraris on the floor of the shop and they even smell different than other cars!

The real reason a Ferrari is special is that they take customization to a level that makes it feel like you are designing and building your own car. This is somewhat hard to do at a global scale but it's really in their DNA and what sets them apart. This is where the very high margins (and prices) come in. It matters though. Owners get a car that is uniquely theirs. In contrast if you spend $900K on a Porsche Spyder you basically get the same car anyone else has that ponies up the money.

Click image to see roadshow slides (PDF)

"Real Ferraris" are in the mid-six figure range with the very high end, highly-personalized and collectable editions costing upwards of $1M. The motto of the company isn't growth but rather to "always sell one less car than the market demands." Exclusivity is part of the key to value of the Ferrari brand. The closest thing they have to a mainstream car is the (very nice!) California T which will set you back over $200K.

But the IPO is more like a Chrysler K-Car. Ferrari is the king of the super-high-end sports car category. They have been selling a little over 7000 cars per year for the last three years running and generating revenues between 2.2B and 2.8B Euros. Margins for the last six months were 15% (EBIT) and 10% net. Growth however is limited by the company strategy of exclusivity and personalization. But the proposed price range for this IPO puts the company at a very lofty valuation. Furthermore the shares offered now will be swamped when the remaining 80% FCA stake is spun off in early 2016.

The deal itself is to offer 17M to 19M shares at $48 to $52 which is about 10% of the company. All the shares are secondary (coming from Fiat Chrysler). The remaining 80% owned by Fiat Chrysler (FCA) are to be spun off to existing FCA shareholders sometime in the earlier part of 2016. Anyone planning to own stock going into next year will want to keep in mind that these new shares will all be coming into the market at one time. Based on the very high valuation proposed the best way to play Ferrari is to buy some FCA. FCA (NYSE: FCAU) has jumped from $12 to $16 this month. Some of that is certainly in anticipation of the RACE offering but may still have more to go.

Useful resources to learn more include the Ferrari IPO Slides , the Prospectus and a good summary posted by the WSJ on what they found "under the hood" of the filing document .

Ferrari owners are "True Fans" however. One third of them own more than one and 60% of new Ferraris are sold to existing owners! Clearly we are talking about very high net worth individuals here. Part of the foundation of the growth story is that Ferrari has access to this growing population of very rich people around the world. Most of that growth will be coming from Asia and EMEA in the future.

Other more dubious parts of the growth story involve leveraging the Ferrari brand in different places ranging from technology products to jet interiors to sports equipment. Even more bizarre ideas are furniture and real estate. Some of these could work. In fact another company we have written about here, Malibu Boats (NASDAQ: MBUU) would probably be interested in collaborating on a Ferrari-designed interior for their high-end performance sports boats. Maybe even more if we consider carbon materials and aerodynamics.

From investment standpoint these efforts don't move the needle, either on the top line or in margins. That means they are more of a distraction than a part of the investment case. There is some added risk that the execution of these plans can actually diminish the brand if they are not implemented well. It's hard to match the impact of the real thing when making a piece of furniture or technology equipment.

Ferrari also capitalizes a significant portion of their R&D. It's not unreasonable but it does mean there are additional moving parts to the P&L. For example in the most recent full year 330K out of 745K was capitalized. This amount is about equal to their total operating profit for the year. Again we are not saying there is anything wrong with this but decisions about how to spend R&D dollars in any given period can have varying degrees of impact on reported results.

After the IPO there will be 189M shares out. At the $50 mid-point that puts the market capitalization at $9.5B. In addition the company will have between 2.3B and 3B in debt (depending on what "other liabilities" below the debt line represent. If we are generous that would put the EV/sales ratio at 4x. The table below shows that on a relative basis the number looks high. The range is from 0.3x to 1.5x for BMW. The fact that FCA is at the bottom lends some support to the idea that the best way to play the RACE IPO is to buy some FCA. TEV/EBIT works out better - using 500M for RACE the ratio is 24x so not much better there either.