Description

Ferrari (RACE US) How a Change in Strategy Risks Destroying an Enviable Franchise

Contents

1.       Summary

2.       Valuation – what is Ferrari worth?

3.       Background: History and what has made Ferrari special

4.       Going public, IPO Implications, and the end of the Montezemolo Era

5.       The Ferrari business model and importance of special series

6.       How Ferrari is Growing Volumes and Price and What it Means for the Business Model

7.       Reviewing the Potential Risks to Accelerating Volume Growth:  Shortening product cycles, volume growth, Accelerating order cycles

8.       Reviewing the Risk to Aggressively Raising Prices

9.       Competition – More Manufacturers and an Increasingly Large Aggregate Volume Number

10.   The Hypercar Segment

11. Cyclical risks vs secular risks.

12. An Irreversible Trend                          

13.   Ride-Sharing Services.

14.   The Green Movement and the Move to Electric Cars and Autonomous Vehicles

15.   Conclusion

Summary

Ferrari ranks among the world’s strongest brands, making dreams come true for many of us who grew up with the poster of a beautiful red car with the yellow and black badge of the prancing horse.  While the Italian company’s pedigree in racing makes the performance of its cars an obvious selling point, what has historically made Ferrari different from other sports car makers is exclusivity. By carefully constraining supply below the level of demand, the company has historically managed to maintain not only its exclusivity but also reduced the rate of depreciation for its cars compared with other exotic car makers. This strategy has also helped reduce the cyclicality of their production thereby helping the company avoid the fate of competitors such as Lamborghini and Aston Martin who have gone bankrupt multiple times.  With the inherent growth pressures emanating from becoming a public company, Ferrari has dramatically changed the strategy that was the core of its success for nearly 70 years and within the next two years expected to double production to 12,000 cars. Long time former Ferrari CEO Luca Montezemolo firmly believed the special sauce of the Ferrari business model lied in keeping production below 6,000 units.  Interestingly, this dramatic increase in production is happening at a time when the competitive landscape is becoming markedly more exigent, while the longer-term future of exotic cars is increasingly uncertain as the world moves toward electric, and eventually self-driving cars.  Infatuated with the near-term growth in earnings, Investors have pushed the multiple on Ferrari stock since going public up threefold from 15x to 50x making it one of the best performing stocks in the market. However, as the company’s earnings have grown substantially on the back of both higher production and higher prices, the earnings have also become more cyclical, as the brand has expanded into the entry level segment also increasing the percentage of cars sold on credit.  Given the lagged impact of the order book and the market perception created by many years of undersupplying the market, the negative implications of the change in the business model are not yet evident in the company’s reported financials. Therefore, over the last three years the company has seen the marked benefit of higher production, without the medium- and longer-term impact on demand and pricing power that comes from lower residual values and lower exclusivity. However, for the first time, we are starting to see signs of price weakness in the secondary market.  We suspect that as customers begin to understand the effect of Ferrari’s change in strategy, on exclusivity and the true cost of ownership relative to other brands, Ferrari risks losing its most valuable and differentiating assets. This would result in the company’s earnings peaking in the next 18 months and then declining, even outside of a recession. The contraction in the multiple would likely be most dramatic.

Valuation – what is Ferrari Worth?

As RACE hovers near its all-time high at around $173, short interest is de minimis, and there is a strong consensus that Ferrari is something other than an automobile manufacturer because they “pre-sell” their product. We plan to walk through and address all of the bull arguments and why most of them are flawed. To value RACE, we believe that to arrive at a fair value price objective, investors should consider a reasonable comparison and look at VOW GY (which owns Porsche, Lamborghini and Bugatti) and is far further along in terms of adapting to the new regulatory regime.  That stock trades at <6x 2020 and <5x EBIT. If you look at 2023 EPS (after full introduction of the SUV) you see consensus at €5.84 x 6 €35 then you can discount back from there with whatever one believes is a fair discount rate. More importantly, we encourage investors to examine the change in business model, and the resulting consequences, which ultimately is the likely catalyst to change the way people see Ferrari.

In the current environment of low growth and low interest rates, it is not surprising that growth and quality companies trade at big premiums. Many of these highly valued companies deserve a premium due to their true secular growth, others because of their truly defensive characteristics.  Like most people, we love the Ferrari products, but we are confident that Ferrari has neither of these characteristics. We believe the company’s near-term aggressive product expansion, volume acceleration and price increases, are not only being confused with long term growth potential but carries within the seeds of destruction of what has made this historical brand so iconic.  Ferrari is very likely to see its peak in earnings within the next two years, but we suspect that by the time it is obvious that earnings have peaked, the multiple will already have contracted significantly. The narrative will then change to what role does Ferrari have, if any, in a world of fully electric autonomous cars, where efficiency and safety are the deciding factors. Raw, loud, driving experience, and sexy design will be irrelevant by then, as will the exclusivity of ownership.  We will refrain from dedicating too much time and analysis in this piece on the long-term issues as we understand most investors have very short investment horizons, but it is still somewhat shocking that a stock can trade at 40x or 50x cash EPS when the longer-term outlook is this challenging. However, we think even near to medium term, there are plenty of things that should make investors think twice about holding, let alone buying, this stock.

Background

Ferrari is a great company making great products. Since Enzo Ferrari founded the company in 1939 and with additional resources provided by Fiat’s majority stake in 1969, the management has developed a highly desirable business model.  The company effectively leveraged its increasing successes in racing into its street cars both in terms of technology as well as exclusivity. While the volumes of cars produced grew with the market, the company stayed laser-focused on making sure to protect its exclusivity by always underproducing relative to demand and by focusing exclusively on the highest segment of the car market.  There is no doubt the company deserves praise for its strategy, but it should also be said that this was made easier by Ferrari not really having much real competition in its core segment of the market. Porsche, while also having a rich racing history (albeit not in Formula 1) has historically followed a different business model operating predominantly at lower price points where the market is larger. Aston Martin has historically focused on the GT segment (think sport touring) while Lamborghini’s historical rebel made it unappealing to a large part of the core Ferrari customer base of “gentleman racers”.

Early winds of change and IPO Implications:  The end of the Montezemolo Era

While the more dramatic change in the business model is taking place since the company went public in late 2015, management disagreement around the strategy that had made Ferrari such an iconic brand already started taking place a few years earlier. After 23 years as a president of Ferrari, Luca Di Montezemolo finally stepped down from Ferrari after the highly publicized clash with Fiat CEO Sergio Marchione about a year before Ferrari actually went public.  Arguably knowing the company’s secret sauce better than anyone, Montezemolo was highly concerned about Marchione’s plans to significantly increase the production at Ferrari. Montezemolo argued that while the market was growing, it was core to the Ferrari business model to keep production below 6,000 units. Marchione was telling potential investors production would sharply increase over the next few years to over 10,000 units with the view towards 14,000 units by 2022.  Marchione wanted to produce twice as many cars as Montezemolo thought was the true limit maintain long term exclusivity for the brand, so in the eyes of the former president of the brand. It was a strategy where sales and profits could rise significantly over the next few years, but the true cost of such growth would only become apparent a few years down the road. Montezemolo knew the number of high net worth individuals was growing but he also knew that the expanding competition, particularly from McLaren, and falling barriers to entry due to electrification, make it more important than ever to control supply to maintain exclusivity. However, Montezemolo was replaced by Fiat CEO Sergio Marchione shortly before Ferrari went public in October of 2015.

The offering was by every measure a great success as the CEO went to great lengths to convince the capital markets that Ferrari was not really a car company, but a luxury brand and as such be both valued as one and followed by wall street analysts covering luxury brands and not automotive companies.  The company went public with a valuation multiple 100% higher than the automotive sector as Marchione pushed hard on the strategy to grow not only production but also pricing, to the delight of investors and analysts alike. The valuation premium to the automotive sector went from 100% premium to 300% premium as the cash EPS multiple went from 15x to 50x.  As the multiple expanded further, Marchione argued that the benchmark for Ferrari was not the luxury sector overall, but the highest margin and multiple company within the luxury sector, namely Hermes. The company today trades at the same P / cash EPS and the same EV / EBITDA multiples as Hermes today.

The Ferrari business model and importance of special series

Historically Ferrari has divided its products into two segments, mid-engine and front engine.  The mid-engine products are what most people associate with a brand, the mid-sized sports cars.  The front-engine, or GT segment has traditionally appealed to an older customer. In addition to constraining annual supply, Ferrari has traditionally introduced a new model ever 5 years, with the last year of the cycle seeing the introduction of the special version of the outgoing model.  Typically, the special version was only offered on the mid-engine model, but over the last few years, Ferrari has increasingly started offering special version vehicles in their front-engine segment as well. It is critical to understand the importance of the special version in the Ferrari ecosystem. It is a “limited” production vehicle that is essentially a more track-focused variant of the outgoing model.  These cars have during periods of time, not only seen less depreciation that the core mid-engine cars on which they are based, but in many cases actually appreciated, with Ferrari touting the appeal of these cars as much as investment propositions as race-ready performance cars.  Given these factors, Ferrari reserved the allocations for these cars to their better customers.  Without question, this has helped. However, the significant upcycle in exotic cars witnessed from 2005 to 2015, increased the quantity of potential customers who started buying regular range vehicles to fall into the factory’s good graces, with the hope of gaining an allocation. The expectation with this strategy is that the profits they could make on one of the special versions will more than offset any losses they take on regular range vehicles.  We are not saying that customer do not enjoy these cars, but rather, that they would buy less of them without the promise of the valuable special version allocation. Furthermore, the ultimate keys to the Ferrari’s promise land is the allure of an allocation to the company’s even more limited hypercars, top-dollar sports cars, embedding the latest racing technology, which the company historically introduced every 10 years. While this is a perfectly good strategy showing the company’s success at managing supply, it demonstrates how sensitive the business model is to the perception of exclusivity, investment potential and residual values of the special series.  The risk is therefore producing too many “special” series to the point that they become less “special.” Once customers stop believing that the allocation has value, they will stop buying extra cars in order to receive access to the special series allocation. While we are concerned that Ferrari is already ramping production and introducing too many models for residual values and exclusivity to hold, what is more concerning is the ramp in special series cars. Ferrari’s production has gone from 5,000 to 10,000 but the special series has gone from 1,200 to 6,000 for the core mid-engine model. In addition, Ferrari is increasingly offering a special version model of their front-engine range model. They are also effectively increasing their volumes of their hypercars, by introducing their “retro” hypercars in the same price category. This results in hypercars being built every 5 years as opposed to every 10 years. Finally, in addition to offering more new models, their core product cycle is moving from 5 years to 4 years.  It is hard to argue that any one of these strategies don’t put incremental pressure on residual values, let alone all of them combined. This is not to take anything away from the great cars the company makes, but it certainly decreases, if not removes entirely, the one factor that has made Ferrari so different from other brands. When true supply no longer outstrips demands, both margins as well as the valuation multiple are likely to fall sharply.

With a model that for decades has pre-sold cars at below market-clearing prices and maintained a list of favored customers, the sales positions at Ferrari dealers has been what can only be described as easy. With Ferrari dealers allocating vehicles much like Goldman Sachs allocates hot IPO shares, the process has been akin to doling out free money. This decades long process has instilled a sense of confidence that it will continue forever. For the first time in history, Ferrari dealers are calling potential customers on the phone to solicit sales and determine if customers want to buy a car and have the ability to do so. If you are a "Ferrari Guy" or an exotics expert, you know this is a remarkable shift. Soliciting customers is simply unheard of for Ferrari and a dramatic aspect of the changed model, as well as a consequence of increased price, production and competition. For decades, the customer used to be lucky if the Ferrari salesman would speak with them when they entered the store. This is indicative of the arrogance, exclusivity and mystique of the brand. Today, residual values are declining while new designs are neither compelling for most Ferrari enthusiasts nor receiving the glowing reviews that were ubiquitous in years past. And competition is ramping up with staggering volumes. The scarcity value has eroded, and the “list” exclusivity has been fully-played. We believe we are at the beginning of the end of the easy and glory days for RACE. This cyclical auto manufacturer trades as a mega-cap growth company with an unsustainable multiple, and consequently, is a compelling fundamental short in our estimation. The company is riding on past F-1 glory in an industry that is headed towards fuel-efficient, self-driving vehicles and the business model change will prove to be a devastating blow.

How Ferrari is Growing Volumes and Price and What it Means for the Business Model

In order to continue to grow the top line Ferrari plans to grow volumes through a three-pronged strategy.

1. Accelerate product cycles by 20%, releasing a new core v8 platform every 4 years as opposed to every 5 years as it has done historically.

2. Grow the amount of “special edition” cars, both in terms of what platforms they make “special edition” cars on as well as significantly growing the volume produced of each “special” edition.

3. Expand the product range, particularly into high-priced Utilitarian segments like SUVs.  In addition, they plan to raise prices at a faster rate than they have done historically.  If significantly higher volumes both of range models and special editions combined with higher prices for products for which residual values are critical sounds too good to be true, well, we agree. It is simply not possible. This is particularly implausible when operating in an industry where the competitive landscape has become significantly more challenging. 

Reviewing the Potential Risks to Accelerating Volume Growth

1. Shortening product cycles accelerates depreciation of the prior model introduction, increases the cost of ownership (as most Ferrari customers trade in their prior model when they get the new one).  Not only does it shorten the time period during which a Ferrari is the new model, but it also increases the overall supply in the market of vehicles putting further pressure on residual values.

2. Increasing the amount of “special edition” volumes and increasing the frequency of special edition releases, inherently makes them less special thereby accelerating depreciation.  This has broader repercussions beyond pricing power for special edition cars.  Beyond the appeal of owning a special edition car, historically special series cars have been produced below demand, which means that not only have they not depreciated as much as other cars, but in fact they have at least for a period of time, appreciated. This has been particularly acute after the great recession as growing social acceptance of sports car (the driver is no longer broadly stigmatized as having a mid-life crisis) combined with ever falling interest rates increased the appeal of these cars as investments, not unlike art or jewelry. In fact, the appreciation in the last cycle was significant enough to create what increasingly looks like a bubble.  This made these special edition cars so desirable that customer would go beyond simply buying range cars to become better customers, but even purchasing cars they actually did not want (in particular models that were harder to sell such as the FF, GTC Lusso and the California). Looking at the most popular Ferrari messaging board, one finds many examples of customers that bought a car they didn’t want, in many cases selling it right back to the dealer at a big discount. Obviously, not only does this inflate the volumes of these cars beyond the natural demand, but it also accelerates the natural depreciation for model that are already not as desirable and therefore depreciate more quickly making the cost of ownership for the natural buyer of these models even higher. As special series cars are produced in larger volumes relative to true demand (in addition to the underlying price increases) it will significantly reduce their investment appeal.  This is a dangerous strategy given the collateral impact on other Ferrari models. We believe the bubble of the special series already hits its peak with the 458 Speciale Aperta (2016) and the F12 TDF (2016). We think the tide is turning with the 488 Pista. Customers that invested heavily to get an allocation of the 488 Pista (by buying other cars) in the hope that the Pista would increase significantly in value, are finding that an ever-increasing number Pistas are coming back to the secondary market. While their owners are still asking for a premium ranging from 10% to 20% of the price they paid, our checks indicate that the few of them that have actually sold, have done so between zero markup and a mark-up of 50K USD. This means many of the people have invested hundreds of thousands in devaluation of other cars are significantly upside down. We suspect these losses will become bigger as more and more cars come to market as we delve deeper into the delivery cycle.  The fact that many cars are entering the secondary market with virtually no miles, also makes one wonder about how units were actually real demand, versus speculators trying to game the market. While it takes some time to burn the goodwill that any brand has generated with customers, people do learn, so it will be interesting to see how eager these customers will be to sign up for the new special series cars that Ferrari is producing in ever greater numbers.

3. By accelerating order cycles and increasing the number of models, the company also makes it less appealing for customers to order a car as opposed to buying one off the lot (new or used). It is less appealing to order a car, due to the fact that typically the buyer waits 18 months to take delivery of a car, and there will be other cars announced prior to the buyer taking delivery. So, by the time one actually takes delivery, you are no longer driving the latest and greatest.

Reviewing the Risk to Aggressively Raising Prices

Since going public Ferrari has repeatedly been speaking about the opportunity to raise prices to its customers above and beyond what it has done historically.  We agree that historically when Ferrari was judiciously limiting production, the company could have increased prices further. Effectively, this incremental margin was accruing to their customers and their dealers, thereby increasing loyalty and the “legend of Ferrari.” By leaving some meat on the bone with pricing below customer willingness to pay and while restricting production volumes, Ferrari created an opportunity. Many customers recognized that if they ordered a car new (particularly if the vehicle delivery was early in the production cycle) upon delivery, the car could be driven for limited if any depreciation as you could sell the car back to the dealer for close to what you paid for it and as the price in the secondary market was above MSRP even for a slightly used car, the dealer could sell it to someone else and still make a margin.  (This flew in the face of the conventional adage about how much depreciation a normal vehicle would be subjected to for merely driving it off the lot.) To receive an early car (call it, first 18 months of production) if a customer had not been a new car buyer before, one had to buy a few used Ferraris from the dealer to fall into the dealer’s good graces. Clearly by raising prices from the manufacturer relative to its true clearing price, you remove part if not all of this cushion, a cushion that helped the dealers sell not only new cars, but also used cars. Increasing volumes produces further reduces any cushion that is left. Shortening the product cycles, reduces the cushion even more. Given that Ferrari is now doing all the above, I suspect the depreciation curve will look quite different going forward. Remember, depreciation is critical in a business in which what matters is the cost of ownership, not only the upfront price.  Raising the new car price and reducing the trade in value makes the math quite a bit worse for the prospective buyers. Add significant variety and volume of new competition to this and RACE may have an issue.

Competition – More Manufacturers and an Increasingly Large Aggregate Volume Number

Ferrari has always had some competition, but its exclusive market positioning (over 100% premium vs. comparable Porsche) and its racing pedigree (Lamborghini can be beautiful and more flamboyant but has not been perceived to have the same class and legitimacy) has allowed it to operate in a class of its own.  Over the last 5 to 10 years we have seen the competitive landscape really start to change. Porsche has increased production in its GT program with price point and exclusivity approaching Ferrari for many of its models, while Lamborghini has gained broader appeal after introducing the highly successful and less flamboyant Gallardo model. The growing strength of the Lamborghini brand is in no small part thanks to its acquisition by Volkswagen. Not only did VW provide Lamborghini its badly needed financial stability after several bankruptcies but is also gave the brand access to the full R&D resources and knowhow of the Volkswagen Group. The Volkswagen group owns Porsche, Bugatti, and Bentley among other brands.  However, we believe the most important change in the competitive landscape came in 2012, when Ferrari’s long time Formula 1 competitor, McLaren, entered the sports car market.

McLaren previously had limited forays into this market in the early 1990s with the limited release McLaren F1 (just over 100 units) and the mid-2000s with its JV with Mercedes, but this time McLaren made a strategic commitment to the sports car market.  With the McLaren 12c, the company offered a car at a similar price point to Ferrari’s production series and with comparable if not better performance. McLaren has a similar racing pedigree to Ferrari, and with similar if not superior technology, so this was the first time Ferrari actually saw a legitimate competitor.  Since the introduction of the 12c, McLaren has introduced a number of other models, and in the span of 5 short years, it has gone from not being in the sports car game, to produce 4,806 cars in 2018. (For reference, Ferrari sold 9,251 cars in 2018.) 

While Ferrari has built strong customer loyalty over many years, Ferrari customers and even more would-be customers finally have a real alternative to Ferrari when considering a purchase of their next sports car. McLaren progress been remarkable. The12c, while delivering blistering performance, was in the views of many Ferrari customers and some automotive journalists not “emotional” enough, with the sound and the design being too “clinical.” McLaren took this feedback to heart, and its later models have not only become more edgy in terms of design but also provide a more emotional driving experience.  With the latest release, the McLaren 720s, for the first time, we are seeing many hard-core Ferrari customers having to admit that this is now a real alternative for their next purchase. In addition to becoming an increasingly powerful competitor, McLaren’s presence has done something else to the supercar industry. McLaren has accelerated the rate of model introductions while also incorporating the latest technology in its current models, as opposed to reserving that for the special edition cars, the way Ferrari has historically done this. Both of these dynamics make it more difficult for cars to hold their value because there is always something new and better around the corner, and the allure of having access to a special edition car diminishes as the technology differential declines, if not disappearing completely.  Finally, McLaren also produces its own highly desirable special edition cars, thereby competing intensely for this group of super wealthy buyers. While there is no doubt the market for sports cars have been growing, brands have more than met this demand making the argument about exclusivity and investment of these products increasingly difficult to defend. 

The Hypercar Segment

Sitting atop the sports car pyramid is a separate category of cars, commonly known as the “hypercars.”  Their prices are several times higher than “standard exotics” and vary with model and the special series and start at over $1 million.  Historically these cars used to be introduced only once every 10 years for Ferrari and Porsche and feature technology and performance that were a significant step ahead of other models. Over the last three decades Ferrari released the F40, F50, Enzo and LaFerrari while Porsche released the 959, the Carrera GT and the 918 Spyder.  Over the last few years, this segment has attracted new entrants including Pagani, Koenigsegg, Bugatti, Aston Martin, Lamborghini and McLaren.  For Ferrari, this segment is important for a few reasons:  first, it is the ultimate in exclusivity, so Ferrari uses these allocations as a carrot for its customers to buy other models. Second, these units are extremely profitable, so even though the volumes are lower they are significantly accretive to margins.  With the entrance of McLaren into the competitive arena, the timing of these releases is changing. McLaren is now on a 5-year cycle, with the P1 release in 2013 and Senna in 2018. Ferrari is also effectively now on a 5-year cycle. They released the LaFerrari in 2014 and started deliveries of the Monza in 2019.  Ferrari positions the Monza as a new category given its retro design but is selling the car to the same buyers as its other hypercars. Arguably, this segment is becoming even more oversupplied as not only do we see more competitors, but they are cutting the cycle timing in half. We repeat, there are a lot of rich people in the world that are willing to spend a lot of money on exclusive cars, but these buyers only have so much garage space and only so much time to drive them.  The slowdown in this part of the market will not only slow down the margin accretion to Ferrari but it will also slow down the appeal of the access to the promised hypercar land for many Ferrari buyers.

Cyclicality

Ferrari frequently makes the argument to investors that its business is not very cyclical, pointing to the mid-single digit volume contraction they experienced during the last economic downturn.  We believe this conclusion is incorrect. In 2009, Ferrari entered an entirely new category, the entry level 8-cylinder front engine touring segment with the California. With this move, Ferrari began serving what was at least in part, a new customer base. We therefore think it is more informative to exclude this segment to generate a more accurate like for like comparison.  The underlying volume decline was 35%. With the operating leverage in an auto business, this makes for quite a bit of cyclical risk. Since 2009, the percentage of Ferraris that are financed has been increasing significantly and with a rapidly growing installed base of used sports cars, Ferraris and other brands, we suspect the cyclicality in the next downturn will be higher. 

a.   1981-1982 down 14% (in units)

b.  1990-1992 down 48%

c.   2000-2001 up 5% (There was little competition, and investors purchased exotics, collectibles, and real estate heavily during this period.)

d.  2008-2009 down 5% (However, the Ferrari California was introduced in October 2008 at the Paris Motor Show. If you back out an estimate for California’s @ 1500-2000 units then units were down 32% on a LFL basis. Moreover, there was a substantial backlog that Ferrari was able to work through until the economy improved. During the next downturn, the backlog will be nonexistent (or much smaller) and the competition and inventory much higher.)

e.  New segments (SUV, lower price V8 sports cars like the California are more cyclical). These are areas in which the company did not participate in during the 2008-2009 downturn. (Note – SUV has not been introduced yet.)

·         US Cayenne units down 35% in 2007-2009 and European Cayenne units down 25% from 2007-2009

·         Mercedes G-wagon units were down 29% in 2009

An Irreversible Trend

Ferrari, like all other auto manufacturers, is in the process of dealing with an irreversible trend.  As many who came of driving age as teenagers back in the 1970s, 1980s and 1990s, preparing for and earning your driver’s license was a rite of passage. It was typical that on one’s birthday when turning 16-years-old, one would head to the DMV for that highly inefficient, but glorious driver’s test to secure that ID that commanded the respect of one’s peers, and authorized the holder to drive an automobile. In suburban America, many would obtain their licenses at 15-years-old, or at least have a permit enabling the holder to drive with a licensed adult in the vehicle. In the big cities, it was less common, and is increasingly becoming the exception rather than the rule. I am becoming less surprised by the number of young men and women between 16 and 25 who neither have a license nor the desire/interest in obtaining one.

Times change, and for Baby Boomers, driving a stick shift was common. For Generation X, it was somewhat of a novelty, and for Millennials and younger, the percentage who have even seen a manual transmission, let alone possess the knowledge to operate one is small. Between carpools, public transportation, bike lanes, subways, trains, buses, etc., the anticipation and commonality of those pursuing driver’s education, classroom and practical instruction required these days to obtain a DL, continues to shrink.

Ride Sharing Services

With driving services such as Uber and Lyft now ubiquitous even in small towns, the number of drivers continues to shrink, and consequently, automobile ownership. The evolution within the automobile industry is fairly clear, and while people may debate timing and logistics of how the future will look, few would argue that we are headed away from internal combustion engines, and towards electric, fuel-efficient, and ultimately autonomous vehicles.

The Green Movement and the Move to Electric Cars and Autonomous Vehicles

Regardless of where one stands on the science and prospect of climate change, there is an undeniable movement in our society to reduce our carbon footprint either voluntarily or by government-mandated schedules and requirements. Inefficient vehicles are penalized with “gas guzzler taxes” and increasingly frowned upon. Like mink coats used to inspire envy and admiration, and now prompt chemicals, paint and bleach to be hurled with expletives, supercars such as Ferraris and Lamborghinis now elicit hatred and anger from the income-inequality socialists and contempt from “Green New Deal” advocates who contend that driving such vehicles will contribute to our planet’s destruction within the next 12 years.

From Tesla, to Toyota Prius to Nissan Leaf, both high-performance and mass-production electric vehicles are coming from manufacturers throughout the world.

While the move to autonomous vehicles is likely outside most people’s investment horizon, we think the long-term picture for Ferrari is challenging.  In addition to the medium-term challenge posed by electrification and impact on the competitive landscape and residual values, long term, technology is not Ferrari’s friend.  Looking into the next decade, self-driving cars will become a reality and over time, our understanding is that all cars are likely to be self-driving for the network of transportation to work properly.  We are certain that putting a Ferrari through its paces is an awesome driving experience. However, this is completely lost in a world of autonomous driving. We do not know who will manufacture the self-driving cars of the future, but we suspect the winner will be the one providing the best reliability, the lowest cost, and to the extent that there is a premium segment of self-driving cars, the most comfort.  We don’t think Ferrari competes well in any of these areas.

Conclusion

Ferrari has been a wildly successful and outstanding company and brand for decades. However, things began changing dramatically with the change in management, and since its IPO four years ago. With the change at the helm and need for continued growth to satisfy the public markets, RACE is now “managing numbers” carefully and playing to luxury goods analysts as opposed to auto analysts.  This is not indicative behavior of an unbridled growth stock. While picking the event, quarter or specific catalyst is impossible, with RACE sitting near all-time highs with a nose-bleed valuation, we are comfortable shorting the stock, confident that we will witness the inevitable fall within our time horizon. We will not argue that Ferrari does not make outstanding ICE engines and vehicles. It does. We will argue that others, such as McLaren have more than closed the technology gap. We will argue that at one point, Eastman Kodak made the best analog film. Eastman Kodak was a fantastic company and seemed invulnerable. Sony made the best analog music devices. We loved our Sony Walkmans. But digital products play by different rules, and are on different cost and time curves. Philips, GE, Osram were excellent companies manufacturing incandescent bulbs, until CREE, and other LED manufacturers changed the lighting world. It seems investors can never pay enough for a company in a leadership position, and companies in dying legacy businesses are always too expensive.  See the table from a recent Barclays industry note segregating into ICE only vs. EV vs. some ICE but with EV potential. The leadership players are either Electric Vehicles (or with some hybrid leadership) vs. internal combustion engine companies. The analyst loves buy-rated APTV @ 18x earnings, but neutral on GTX at 3x. Again, so many investors are happy to pay sky-high multiples for the RIGHT model, and companies are never cheap enough if the have the wrong technology.  Fast, loud and fuel-inefficient vehicles that cost as much as a single-family home are a relic of the past, and the business model change will prove its undoing. And this is coming from die-hard fans, and lovers of the brand.

Catalyst

Summary of RISKS to RACE

1. Long-term secular threats

2. Cyclical Business Parading as Luxury Staples Business:  Cyclicality was masked in the last downturn because of a product cycle. RACE will likely contract from ~40x to sub-10x near-term, and then ultimately lower.

3. Automation – Does the internal combustion engine eventually go away entirely?

4. Electronification has done two things. 1.) Commoditized the comparative advantage.  For a fully electric vehicle, the beautiful sound of a high-performance ICE does not matter. If all cars sound the same, there is de minimis differentiation in sex-appeal as there is little performance differentiation among the supercars. Some buyers were willing to pay the Ferrari premium for the sound. 2.) Commoditized the technology – an age-old design shop that designed some of Ferrari’s most iconic cars is now a competitor. As of Frankfurt, they are introducing their own multi-million-dollar car. Rimac, Ariel,

5. Competition:  Lamborghini has increased production from 1200 to 6500 in 2010 to 2018, McLaren didn’t exist last downturn. Aston Martin 6,400 estimated this year (and plans to go to 14,000 in 2022), Mercedes AMG GT units 1,525 in 2018 from 0, Luxury SUV (Ferrari intro in 2022), Lamborghini Urus 0 to 2,500 units.  Bentley Bentayga 0 to 5,000 units, Rolls Royce Cullinan (no units yet), Aston Martin DBX intro 2020-2021 ~4500 unit

6. Lack of Uniqueness: Market is getting a lot more crowded. Drive trains not that special anymore.

7. Excess Inventory:  Exotic car dealers are stacked up with inventory and reducing prices. McLaren are backed up. The McLaren 720 is widely available with low or no miles and can be purchased at huge discounts to MSRP just to move inventory.

8. SUV Introduction is Very Late:  Virtually every manufacturer has a luxury SUV. At $250k+ . Lamborghini Urus 2500, Bentley 5000. Aston Martin – 4k-5k units. Ferrari is late to the party.

9. The increased Production/Proliferation of New Supercars is very bad for residual values.

10. Tracks:  Very few owners “track” their cars.  Most owners drive their supercars on nice days or keep them covered or on display.  A sudden transition to see supercars all being driven at the “track” seems highly unlikely.  

11. Abundance of Limited Editions:  The special status car which used to be so sought after, and in such high demand, is seeing the market transitioning to the ability to buy in the aftermarket.

12. Too Many New Introductions for the Wealthy and Car Enthusiasts:  Manufacturers of supercars are bringing a lot of cars to market – too much volume for the market to digest.