Ferrari Case Study

Ferrari Case Study EXECUTIVE SUMMARY Ferrari is a luxury automotive manufacturer that was founded by Enzo Ferrari in 1947 and is owned under the Fiat Chrysler Automobiles (FCA) umbrella. When Enzo Ferrari passed away in 1998, FCA owned 90% of Ferrari’s stock, while the Ferrari family owned the other 10%. Ferrari is soon to be listed on the NYSE with the 10% of shares to be publicly traded. This report will examine Ferrari’s business plan and strategy and financial forecasts, as well as recommend a share price for the initial public offering. ANALYSIS OF BUSINESS PLAN & STRATEGY Marchionne had a five year business plan. One of the primary facets of the plan was to undergo an IPO, and then split Ferrari apart from FCA, with 90% of Ferrari’s shares being publicly traded. One of the purposes of the plan was to raise cash to FCA through the sale of Ferrari shares, and have part of FCA’s debt transferred to Ferrari. Raising the cash for FCA will be beneficial, but the transfer of debt may cause issues. If Ferrari is seen to be overleveraged, their IPO may go poorly, and have a negative impact on the share price of Ferrari, and in return provide less cash for FCA. In 2015, Ferrari’s balance sheet showed a very unfavorable debt-to-equity ratio, and management must be sure to not transfer too large an amount of debt during the IPO. This relates to another goal of the business plan, which is to make Ferrari have more direct access to equity and debt on favorable terms. The IPO will provide equity financing, but if the company's fundamentals are weak during the IPO or weaken in the future, the goal of favorable financing may not work. Had Ferrari remained part of FCA, it could have received funding indirectly through FCA, a much larger company which may be able to obtain favorable debt and equity funds on its own. However, it is still likely that the spin-off will spur much increased investment in Ferrari. Finally, another major change coinciding with the IPO is Marchionne’s plan to increase production of Ferrari cars. Previously, Montezemolo held the company to strict production limits, but Marchionne plans to boost shipments, particularly to the Middle East and Asia. This will most likely be favorable to investors, as this will provide the company with growing revenue. The increase in production may have a slight effect on the feeling of exclusivity of the brand, but it is not a drastic increase, and it is targeted to select markets, so it should not damage the reputation. EXAMINATION OF FINANCIAL FORECAST The financial forecast for Ferrari in exhibit 8 seems to be a reasonable projection of Ferrari’s financials in the upcoming years. The forecast is fairly conserative and revenue is tied to the number of car shipments. The largest increase in car shipments is from 2014-2015, with an increase of 7%. This period is also the largest growth in revenue of almost 10%. During the time period from 2014-2019, the number of shipments is projected to increase by almost 2 thousand. This makes sense as Marchionne is not following Ferrari’s tradition of a severely limited-production strategy and is interested in expanding production in order to fill demand in emerging markets, especially in the Asian market. The drop in revenue growth from 2014-2015 from 18% to 10% is explainable due to the challenges that the company will face from expanding in various parts around the world. Along with that, Ferrari will owe payments to the parent company, FCA. Even though the revenue growth is projected to decline, the forecast predicts constant EBITDA margins for Ferrari. FERRARI VALUATION To arrive at a valuation for Ferrari, both the discounted cash flow and multiples methods were implemented. Due to the unique positioning, branding, and performance of the company, Ferrari did not have a “pure play” with which to compare its value, as no other luxury car brand had participated in the same industries as Ferrari. To best prepare an accurate valuation, we found that a blend of luxury and automotive companies’ multiples would best represent Ferrari’s value. Financial data for select luxury brands, as well as auto manufacturers is included in the case (Exhibit 6). Given the high volume of European companies using EBITDA multiples, as well as Ferrari competitor, Aston Martin, this group concluded that an EBITDA multiples approach was most appropriate for deriving a value of Ferrari. The multiples were computed by dividing each company’s enterprise value by its most recent EBITDA (2014). This group believes that the 2014 data should be used to reflect a full year’s worth of Ferrari operations, given the seasonality in auto sales, as well as the variability in forecasting future financial data. The multiples were averaged in both the auto manufacturer segment and the luxury goods segment, totalling 9.83 and 13.96, respectively. To maintain an accurate valuation, we averaged these two multiples for our valuation, giving a multiple of 11.89. In applying this multiple value to the 2014 EBITDA of Ferrari, the enterprise value of the company totalled €8.069B. With the 189 million shares outstanding, Ferrari would achieve a stock price of €45.69, or $51.98, assuming an equity value of €8.636B. Despite this share price falling within the acceptable range given in the case, the multiples valuation method can over-simplify the value of a company by reducing its valuation to a single set of ratios. However, the ability to compare Ferrari’s value to other companies by selecting varying industries with which to compare is beneficial for the purposes of arriving at an acceptable valuation. For our discounted cash flow valuation, we used the financial forecasts and other assumptions provided in the case and assignment. In our analysis, we derived free cash flow using EBITDA(1 - tax rate) - change in Net Working Capital - Change in PP&E. This gave us discounted cash flow values of 302, 398, 476, 411, and 384 million Euros for 2015, 2016, 2017, 2018, and 2019, respectively. In our model, we assumed a valuation date of 10/20/2015, one day before the initial public offering, and discounted our cash flows accordingly. This provided a discounted terminal value of 9.393 billion Euros, assuming a long term growth rate of 1.5% and a WACC of 5%. For our long term growth rate, we used 1.5% as a conservative figure as Italy’s GDP growth was low at the time and we did not want to outpace national growth in our model. Assuming net debt of around 2.3 billion Euros and 189 million shares outstanding, we arrived at a share price of 48.12 Euros per share or $54.74. Given the low terminal growth rate, this valuation may be on the conservative side, but is comparable to our multiples valuation. SHARE PRICE RECOMMENDATION Our share price recommendation is based on the average of our DCF valuation and multiples analysis, and is then adjusted to reflect demand for the new shares, corporate narrative, growth prospects, underwriting fees and discounts, and corporate structure. Based on a multiples analysis, a fair value for Ferrari uses a 50-50 weight of luxury brand and auto manufacturer EBITDA multiples of 9.83 and 13.96 to arrive at $51.98 per share. The DCF valued Ferrari at $54.74 per share. For our IPO, we will begin using the average of our valuations, $53.36. Going into the IPO, Montezemolo’s strategy of restricting volume was working wonders for brand recognition, but the company was considering a higher volume direction. This change poses a risk, and management turnover is concerning to investors. Furthermore, the IPO implies a spinoff in which FCA sets Ferrari adrift. This uncertainty does not affect DCF valuation, but is a significant change for the company and has a situational impact on factors such as access to capital. For this reason, the final share price is reduced by 5%. Regardless of this turmoil, Ferrari is a highly sought after brand, and demand is likely to continue to be high. Initially, it seems as though demand for shares will be much higher than the quantity being offered. Additionally, a top branding research firm has labeled Ferrari as one of the most valuable brands on Earth. These added benefits increase the value of the shares by 10%. Finally, there are a number of costs associated with going public. Additionally, the risk of overpricing the shares and being burdened to follow through could put unwanted strain on management to sell more vehicles. Because of these factors, we will discount the shares an additional 10%. The final valuation accounting for these factors is $50.18 per share.