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Fiat's Brilliant Spinoff of Ferrari

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Fiat Chrysler has spun off Ferrari, and the two companies have comparable market caps. Does this mean that more exclusive brands command a premium on the stock exchange?

On Tuesday, Ferrari's second day of trading on the Milan stock exchange, the carmaker was valued at $9.1 billion. Fiat Chrysler was worth $11.6 billion.

How can a company that only sold 7,255 cars in 2014 be worth 78 percent of one that sold more than 4 million? After all, the mass-market automaker earns far more than the premium one. Fiat Chrysler's projected 2016 net income is $2.2 billion, and Ferrari is only expected to make $342 million. Ferrari has a lower debt level than Fiat Chrysler, but the difference is not sufficient to explain the market valuations.

And what explains Ferrari's price-to-earnings ratio of 26 times earnings? It is almost unique in the car industry: Only Tesla trades at a higher one.

Markets Love Legends
Price to earnings ratios of automobile manufacturers
 
Source: Bloomberg

That's not how it's supposed to work. as Aswath Damodaran, a New York University finance professor who specializes in equity valuation, wrote in a blog post in October, when the Ferrari spinoff was announced:

There is a lot of casual talk about how Ferrari will command a premium because of its name and some have suggested that you should add that premium on to estimated value. In an intrinsic valuation, it is double counting to add a premium.

Indeed, Ferrari's -- and any other luxury producer's -- fat profit margins (Ferrari has four times the gross margin of Fiat Chrysler, based on the 2016 estimates) are a reflection of the value of its brand. 

One could theorize that Ferrari's stellar multiple reflects the effect of a strong brand on financial performance. Research has shown that companies with strong brands outperform the stock market index: When Interbrand publishes its marque valuations, the highly ranked companies' stocks jump

But Ferrari is not on Interbrand's Top 100 list, and Toyota, Mercedes and BMW are all in the top 20. There's no correlation between the estimated value of the brands and the earnings multiple for the companies that own Interbrand's top 30 brands (Apple was the most valuable last year, at $170.2 billion). 

Nonetheless, the correlation between the earnings multiples of car companies and the average prices of the vehicles they sell, 0.66, is not trivial. 

Exclusive With a Vengeance
Average price of vehicles sold in the last financial year
 
Source: Bloomberg

It doesn't work this way in other industries. For example, LVMH, the parent company of luxury brands such as Louis Vuitton, Kenzo and DKNY, trades at a lower earnings multiple (16.5) than far less glamorous Adidas (21.7) or Zara owner Inditex (29.1). Apple sells premium products, but its earnings multiple, 10.6, is not much higher than Samsung's 8.7.

With cars, though, a more premium product appears to give a boost to market capitalization. It makes sense because making luxury cars is a more stable business than auto manufacturing in general: Ferrari's sales have been more or less stable for the last 15 years, regardless of the economic upheavals. And should sales decline slightly -- or even be artificially limited for exclusivity's sake -- fat profit margins can always compensate for the loss, as they did for Ferrari in 2013. 

Middle-class customers sometimes buy expensive designer clothing, but they can't afford supercars, or even less expensive luxury automobiles such as Teslas, Maseratis and Jaguars.

Distributing Ferrari shares among Fiat Chrysler shareholders was a genius move by Chief Executive Officer Sergio Marchionne. Other carmakers should do the same with their luxury brands. Great shareholder value could be unlocked, for example, if Jaguar Land Rover could trade independently of its Indian parent, Tata. 

Sure, the Ferrari spinoff shaved off a third of Fiat Chrysler's market cap, but the entire company traded at $15-16 billion, and now the two companies are worth a combined $21 billion.

Marchionne took a risk because Fiat Chrysler's weaknesses are exposed without Ferrari to boost margins and profit. Others in the car industry may not want to be so vulnerable. It might, however, make sense for Volkswagen, which is trying to rebuild after an emissions scandal that may cost billions of dollars. It might need the money it could get by spinning off Lamborghini, Porsche and Bentley, even Audi.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net