Sizzling Demand Promises To Make Ferrari IPO The IPO Of The Year

  • Fiat Chrysler is set to spinoff Luxury carmaker Ferrari in mid-October.
  • Despite the Volkswagen diesel scandal and the ongoing broader market weakness Ferrari shares won't come cheap.
  • The luxury carmaker is, however, solidly profitable and worth buying into. Investors can get hold of Ferrari shares by buying Fiat Chrsyler's shares prior to the Ferrari IPO.

At first glance, the upcoming Ferrari IPO could not have come at a better time, at least in the eyes of investors. Volkswagen A.G.’s historic diesel scandal and the general malaise pervading stock markets in the U.S. and around the world appear to be more than enough catalysts to lower interest in any IPO and consequently push the IPO price down, luxury carmaker's or not. But if you thought that this might be a good opportunity to pick up some shares of the world’s most famous supercar maker on the cheap, then you couldn’t be more wrong. According to Ferrari chairman Sergio Marchionne, Ferrari’s IPO remains on track to garner the 10 billion-euro ($11.2 billion) value that was pinned on the company long before the Volkswagen crisis  rocked the auto industry, and initial demand might exceed 10 times the available float.

So why is there so much interest in the IPO, and can Ferrari’s stock match the performance of the iconic car?

Ferrari IPO: A Fiat Chrysler Spinoff

Ferrari, is no doubt one of the most hallowed names in the auto industry. Fiat Chrysler (NYSE:FCAU) owns a 90% chunk of the company, while the other 10% is owned by Piero Ferrari, son of founder Enzo. Ferrari is a luxury car brand that revolves around ultra-exclusivity, and its shares will be no different--Fiat will only put 10% of the shares up for the IPO while Fiat shareholders will get the other 80%. Meanwhile, Piero Ferrari is not selling his 10% stake in the company. The IPO is expected to take place mid-October. The small float worth about $1.1 billion promises to make trading quite volatile. But that’s not all.

Fiat operates a loyalty voting program which seeks to reward shareholders who are willing to hold their shares for at least three years. These special voting shares cannot be traded, and can only be transferred under special circumstances. This loyalty reward program is designed to encourage a stable shareholder base. This means that there is a strong incentive for Fiat shareholders to hold on to their Ferrari shares for at least three years following the IPO. This will of course crimp trading in the shares even further since it will not only deter trading in 80% of Ferrari shares, but is also likely to reduce liquidity of the shares which might adversely affect share price.

Ferrari IPO A Chance To Own A Profitable Automaker

While we as yet do not have any SEC documents that can give us valuable insights into the company’s financials, it appears as if Ferrari might be a very profitable carmaker. Ferrari finished 2014 with earnings of $275 million euros on revenue of $2.76 billion euros, good for an EBIT margin of 14% and far ahead of the average automaker.

But here’s the catch: growing those earnings will not be a walk in the park. Ferrari deliberately caps its sales in order to preserve exclusivity of its brand. The company sold just 7,255 cars in 2014. Compare that with 120,000 units sold by Porsche and 36,500 by key rival Maserati over a similar period. So with such stringent sales caps, how does Ferrari plan to grow revenue and earnings?

The company says it's got two main growth strategies up its sleeve: to increase sales slowly over a couple of years to 10,000 units, and to introduce more ultra-luxury brands such as the $1.4 million "LaFerrari." Ferrari's F12 Berlinetta starts at around $320,000 and it’s quite possible that high demand and limited supplies will give the company room to introduce a couple more mid-range Ferraris.

Ferrari can also grow significantly by boosting its license revenue. The company realized licensing revenue of $109 million euros in 2014 from licensing deals with the likes of Microsoft (NASDAQ:MSFT), Lego, Puma, Oakley Sunglasses, as well as a host of valuable assets that carry the marquee name including Ferrari World Theme Park in Abu Dhabi, sportswear and watches. Last year licensing revenue contributed 17.6% to Ferrari’s top line up from 16.3% the prior year.

The Fiat Chrysler dilemma

While Ferrari seems poised to survive comfortably as an independent unit, the same can hardly be said about Fiat Chrysler. Ferrari accounts for just 2.9% of Fiat’s revenue and 12.1% of earnings, yet its $10 billion euro valuation is a good 60% of Fiat’s market cap. Just like we saw in the case of eBay (NASDAQ:EBAY) and Paypal Holdings (NASDAQ:PYPL) spinoff, the market is likely to give Fiat Chrysler a much lower valuation post-spinoff.

Buying Fiat Chrysler shares

The mystique surrounding the Ferrari brand is likely to lead to strong demand for the shares, which unfortunately means that the average retail investor will have to pay a good premium to the IPO price for the shares. The best route for long-term investors to take is to buy Fiat Chrysler shares prior to the Ferrari IPO to guarantee themselves Ferrari shares. Even with the expected loss in value for Fiat Chrysler shares, such a move is likely to yield a significant net gain even for short-term investors as was the case in the eBay/PayPal spinoff.

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