Description
Fiat Investment Case – The Last Great European Restructuring
Few appreciate the potential for significant value creation through restructuring at Fiat; most that have followed Fiat for any meaningful period of time are unable to see past historical disappointment and legacy family and government ties to a value-destructive auto division, and overlook the value of Fiat’s other significant industrial businesses. We believe the empire building days of the Agnelli’s (the founding family of Fiat, and one of the most prominent families in Italy) are behind us, and that shareholder value will be progressively restored over the next few years, under the new leadership of an exceptionally shrewd turnaround artist, Sergio Marchionne. In summary, a radical but necessary cost reduction program, coupled with variable contribution from new models over the next 6 months, will bring Fiat Auto to breakeven in 2005 (from a loss of 840mm last year), which we believe will open up several strategic options to reduce/ or elimate investor exposure to Auto. Additionally, through a number of complex negotiating maneuvers, Marchionne has convinced unlikely parties including GM and a consortium of Italian banks, to make good on obligations entered into during ‘better times’, and as a result, net industrial debt is set fall to €3.5 bn from €9.4bn by year end, which should allay investors concerns regarding need for future issuance of capital. The risk/reward at Fiat is dramatically asymmetrical (it would have to be to justify the risks and complexity level inherent in an investment in Fiat). A conservative sum-of-the-parts analysis reveals Fiat trades at a 53% discount to its 2004 sum-of-the parts, and based on targets set by Marchionne for 2007, could have more than 250% upside from current levels (for the sake of brevity, profitability bridges by division are not included but can be found at www.fiatgroup.com in the July 2004 presentation). Furthermore, we believe, based on 2007 targets set forth by Mr. Marchionne, that the company is capable of generating €2.5 bn of free cash flow by 2007, meaning that, with a market cap of €6.6bn, you can buy an industrial conglomerate with leading market positions in agricultural and construction equipment, trucks, diesel engines and auto for 2.6X 2007 free cash flow or less than 10% of 2004 sales, a 70% discount to the European auto sector despite the majority of Fiat’s assets being non-auto, higher multiple assets.
What is Fiat SpA? To the surprise of many, Fiat is not just an automaker. In 2004 auto represented just 44% of Fiat’s total sales. The remainder of Fiat is comprised of Case New Holland, the #2 global competitor to John Deere (21.7% of 2004 sales), Iveco, a European manufacturer of light, mid and heavy weight trucks (19.7% of 2004 sales), Magneti Marelli (8% 2004 sales), the leading european manufacturer of automotive engines and parts. Fiat additionally houses many other assets that when dusted off and examined, are probably worth well more than the value assigned in my analysis. Among them, Ferarri, Maseratti, Alfa Romeo, Teksid (an automotive supplier), Comau (industrial automation), as well 2 prominent Italian newspapers, La Stampa and Corriere della Sera, real estate, and over €2bn worth of minority investments in listed and unlisted entities.
2004 Sum of the Parts
Financials €Mln Multiple Value(€Mln)Comments
Fiat Auto 2004 EBITDA 105 3.0 315 in line with European peers
Iveco 2004 EBITDA 665 7.0 4,655 in line with Man & Volvo
CNH MV+Pref+Ind Net Debt+Pension 5,543
Ferrari/Maserati
2004 Sales 1512 80% 1,210 20% discount to Porsche
Magneti Marelli
2004 EBITDA 297 6.0 1,782 Median of Euro auto suppliers
Teksid 2004 EBITDA 83 6.0 498 Median of Euro auto suppliers
Comau 2004 EBITDA 75 6.0 450 Discount to ABB
Biz Soln 2004 EBITDA 69 7.0 483
Itedi 2004 Sales 407 150% 611 20% points discount to RCS
Less: OH costs -139 8x -1,112 capitalised at 8x
Total EV 14,434
Unconsolidated Stakes Financials €Mln Multiple Value(€Mln)Comments
Fidis Retail Italia 2004 BV 867 1X book 425 49% owned
Other stakes
MedioBanca Mkt value 10,197 -- 184 1.8% owned
RCS Mkt value 3,754 -- 368 9.8% owned
BUC 2004 BV 171 1X book 171 100% owned
Other 2004 BV 919
Total Value of stakes 2,066
Adj for Equity Value
2004 Net Industrial Debt IAS -7,200 (2004 IAS Net Debt - GM -Iveco JV - Edison - less real estate + JV debt) Minorities -907 CNH, Ferrari, Teksid
Convertendo 3,000 Post Conversion
Pension Provisions - 1,100 CNH
Total Adj. -6,207
SOP Equity Value 10,293
Proforma Number of ord. Shares 1,281 Conv @ 10 E
SOP implied share price (€) € 8.0
Current equity value 4,488
Current ordinary share price 5.15
Premium discount to SOP 53%
2007 Sum of the Parts – Assuming Targets Achieved
Est Financials €Mln Multiple Value(€Mln)Comments
Fiat Auto 2007 EBITDA 1765 3.0 5295 in line with European peers
Iveco 2007 EBITDA 665 7.0 6,356 in line with Man & Volvo
CNH 2007 EBITDA 1205 6 7,228 15% disc to Deere
Ferrari/Maserati
2007 Sales 1740 80% 1,392 20% discount to Porsche
Magneti Marelli
2007 EBITDA 347 6.0 2,082 Median of Euro auto suppliers
Teksid 2007 EBITDA 87 6.0 498 Median of Euro auto suppliers
Comau 2007 EBITDA 75 6.0 450 Discount to ABB
Biz Soln 2007 EBITDA 69 7.0 522
Itedi 2007 Sales 410 150% 611 20% points discount to RCS
Less: OH costs -100 8x -800 capitalised at 8x, 25% redn in OH
Total EV 23,943
Unconsolidated Stakes Financials €Mln Multiple Value(€Mln)Comments
Fidis Retail Italia 2004 BV 867 1X book 425 49% owned
Other stakes
MedioBanca Mkt value 10,197 -- 184 1.8% owned
RCS Mkt value 3,754 -- 368 9.8% owned
BUC 2004 BV 171 1X book 171 100% owned
Other 2004 BV 919
Total Value of stakes 2,066
Adj for Equity Value
2004 Net Industrial Debt IAS -4,900 (2004 IAS Net Debt - GM -Iveco JV - Edison - less real estate + JV debt assumed + 2300 of FCF generated 2005-2007 in line with company targets)
Minorities -1000 CNH, Ferrari, Teksid
Convertendo 3,000 Post Conversion
Pension Provisions - 1,100 CNH
Total Adj. -6,307
SOP Equity Value 22,005
Proforma Number of ord. Shares 1,281 Conv @ 10 E
SOP implied share price (€) € 17.2
Current ordinary share price 5.15
Premium discount to SOP 234%
Debt Bridge (E BN) ADJUSTED FOR IFRS YEAR END 2004
Industrial (Bn Euros)
2004 Year End per IAS 9.4
Less: Convertendo -3
Less: GM Cash -1.55
Less: Italegenria -1.8
Less: Iveco Financial Debt
Plus: Cash in from Iveco -0.1
real estate -0.2
Assumption of PowerTrain GM JVDebt 0.55
Pro Forma Debt 3.3
Why believe in Marchionne’s targets? Marchionne’s track-record has gone somewhat unnoticed by many US investors, as well as European sell-side auto analysts who cover the company, as his past leadership experience has been largely Swiss-based and has ranged widely in sector from aluminum to industrial services to chemicals. Marchionne has successfully taken two companies, Alusuisse and SGS SA from the depths of seemingly inexorable problems, to highly profitable, best-in-class performers. At Alusuisse, Marchionne brought a cash burning aluminum maker with negative operating margins to a 12% margin over 3 years, (exceeding the aggressive targets he had set for himself), split off its chemicals subsidiary (Lonza), and then sold Alusuisse to Alcan at a premium. At SGS, Sergio inherited an industrial testing company with 5.9% EBIT margins and a host of legacy credibility issues. In less than 2 years, Sergio took margins to 12%, best-in-class, before leaving to join Fiat. Both stocks tripled under Marchionne’s leadership. Sergio is not new to analyst skepticism. Not one analyst believes Marchionne will make the targets laid out for 2007, just as no one believed his targets at SGS or Alusuisse. Sergio prefers to achieve his goals and then comment, which seems to leave the analyst community somewhat dumbfounded and skeptical. It may or may not be relevant to readers to see the evolution of analyst skepticism in historical turnarounds, but I have included a timeline of key events in the turnaround at SGS, analyst reaction and share price developments (included at the end).
Detail on Fiat Auto Holdings (FAH): One reason the risk/reward is so attractive at Fiat Group at this point in time is that the market ascribes no value to the possibility of a turnaround of auto and an ultimate exit likely through split off or sale. While auto remains a cash burner, and critics are right to be skeptical that it can ever be turned around, I believe that is all in the current price. Fiat never had to deal with foreign competition until several years ago, as incentives were given to Italian consumers to buy Italian; shortly after these incentives were rescinded, Fiat’s market share in Italy of over 50% plummeted to today’s current 27% level. In 2004, FAH lost €840mm in 2004, and Marchionne has guided to a loss of ~€300mm this year, with a return to profitability in 2006 (See July 2004 for detail on 2004-2007 EBIT bridge). Unlike most, we believe this target is achievable in spite of the dismal macro conditions facing Fiat. Here’s why: the degree to which Fiat auto was mismanaged historically cannot be understated: hundreds of millions were spent on senseless campaigns in countries that made Fiat no money, on R&D that never materialized in any marketable vehicles; layers upon layers of white collar bureaucracy existed within the corporation; entire divisions existed that top management knew little about; plants ran at 60% capacity and were never rationalized despite the drastic step change in demand for the company’s vehicles; fleet and other unprofitable vehicles, which accounted for more than 15% of total volumes were sold under programs termed ‘kilo-zeros” which effectively meant they were given away at a substantial loss at the end of each month; quality perception was poor and dealer network was inaccessible. Marchionne has taken a hard line and is now implementing sorely needed tough medicine the division, the results of which I believe we will start to see on May 10 when the company reports 1Q results. The selective selling and intense cost-cutting regime that Mr. Marchionne is implementing, we believe, will be sufficient, even assuming current anemic conditions persist, to meet and possibly exceed his 2005 targets, in spite of the monthly reported sales declines of ~15% thus far in Q1. Q2 will show a significant improvement sequentially, and will reflect the full impact of cost-cutting, as plants and head-quarters were rationalized during the first week of Q2. We believe cost saves from personnel reduction alone could be north of €200mm annualized. By the beginning of 2006, over 80% of fiat volumes will be turned over, with the launches of the Croma (happening within weeks across Europe), and most importantly, the Punto, slated to be released in the back-half of the year. We believe volume expectations are modest.
Additionally, Marchionne has assembled a skilled team of leaders to aide in the turnaround effort, including Karl Heinz Kalbfell, who was instrumental in the success of BMW’s Mini Cooper, to head up Alfa Romeo. Seperately, Fiat has engaged in a provocative and bold advertising campaign under Luca DeMeo, a respected marketer and brand manager taken from a competitor, to re-build the Fiat image in the eyes of the consumer. The initiative is similar to the one espoused by Renault in its turnaround several years ago, and we think will be successful.
Other divisions: Marchionne has set fairly detailed targets for the remainder of the assets by 2007, but given the exigency at auto, I would expect the attainment of these targets to be back-end loaded.
CNH: CNH Global was formed on November 12, 1999 by the $4.6B acquisition of Case Corp. by New Holland, in just one of many examples of Fiat empire building. Fiat today owns 92% of CNH (84% through equity holdings and 8% through a convertible instrument). Due to a limited float and a somewhat inaccessible management team, analysts are loathe to follow the name, and few are even aware of the targets Marchionne has set for the business in 2007. Unquestionably, integration of the Case-New Holland merger was an unmitigated disaster. Margins fell from a pre-merger 15.8% to just 4.4% in 2004, some 700 bps below John Deere for the same period. Deere capitalized on CNH management missteps (largely relocating critical distribution centers and alienating customer base) to gain market share. Over $500mm of synergies were targeted, but any savings have been overshadowed by substantial customer loss and a decision not to price competitively (on average at a 20% discount to Deere) despite a highly fragmented market and dependent customer base. We believe that ultimately the minorities of CNH will be bought in, and de-listed from the NYSE, allowing Sergio to manage CNH’s turnaround in a more hands-on manner and eliminating the layers of management and bureaucracy for which CNH is condemned by analysts. The ~10% margins being targeted in 2007 are no doubt ambitious but Marchionne is confident that based on simple actions to restore pricing, and proper integration of these under-managed assets, he can achieve his targets. CNH is likely a 2006 story, when auto has returned to FCF positive and been effectively “de-risked.” CNH has interim management in place after a recent management shake-up; we are awaiting more permanent leadership and directional evidence that Sergio is moving toward his 10% target. But given the oligopoly structure of the business and the leading market positions, and even assuming the cycle turns, it seems reasonable that at a minimum, margins should reach 7% (allowing 300 basis points of margin contraction based on the cycle, as guided by Fiat).
The remaining assets are relatively straight forward and are showing already the effects of the restructuring program announced in 2004. Iveco achieved a 3.8% operating margin in 2004, up from an anemic 1% in 2003, and we expect further improvement in 2005 of 4.5% and ultimately, per guidance, ~7% margin in 2007. Details on Profitability Bridge by division can be found in Fiat’s July 2004 presentation.
While I am confident that Sergio will achieve and ultimately exceed the targets set forth, a return to free cash flow break even or positive at FAH will enable a significant amount of value to be unlocked, as auto will be able to stand on its own, and Fiat SpA will be re-rated as a Capital Goods stock. At current share price levels, expectations are completely washed out, liquidity concerns are foremost on the minds of investors (despite the preponderance of evidence that suggests the group has ample liquidity), and despite the Mr. Marchionne’s outstanding track record, investors will not give any credence to the ambitious targets he has laid forth because of legacy disappointment and negative auto sector sentiment, making for a significantly asymmetrical risk reward in Fiat shares. There are, admittedly, a lot of complexities that I have not delved into for purposes of time, namely the technicalities on the accretive convertible instrument, the Italgenria stake that reduces debt by €1.8bn, and the terms of the unwraveling of the GM JV -- I am happy to explain how these items work but satisfactory explanations can also be found in recent presentations in the company's website.
Addendum:
Evolution of Analyst Skepticism of Sergio’s Ambitious Targets at SGS:
1/22/02: Share Price 260CHF
1/23/02: Share Price 292 CHF; Sergio Marchionne Announced as new CEO of SGS, outlines LT Target of 10% margins (from 5.9%)
2/12/02 Share Price 328 CHF; Deutsche Bank: “[Despite guidance], we do not believe SGS currently has the right structure to achieve [the 10% targeted margins]. We have in the past argued that one or more acquisitions could profitably leverage the current global network of offices and laboratories. Nevertheless, on the basis of the current structure, our forecasts for 2002 and beyond do not anticipate material improvement in returns. Whether the new management will be able to increase internal efficiency remains to be seen, but for the time being we do not see a reason to change our forecasts.”
3/25/02 Share Price 390 CHF; Deutsche Bank: “Although the company gave an upbeat outlook statement in the analyst presentation, they remained very vague about how targets are to be reached. The new CEO Marchionne did reiterate the long-term targets of 10% EBIT margin, 10% growth and 20% return on equity. At the same time he referred to the company’s AGM on 2 May 2002 for all questions regarding cost cutting measures, spin-off considerations and acquisitions. Giving management the benefit of doubt we have increased our forecast EBIT margin for 2003 from 7.1% to 8.1%. On valuation grounds we reiterate our Market Perform recommendation.
1/15/2003: Share Price 460 CHF; Deutsche Bank: “SGS shares outperformed the market by 84% in 2002, pricing in a fair bit of the three-year plan. Their current valuation does not leave much room for upside in our opinion and the speed at which the operating margin improved in H2 will play a critical role in future share price performance. We re-initiate coverage with a Hold recommendation and a price target of CHF 440.
1/16/2003: Share Price 465 CHF; Detusche Bank: “SGS reported full year results yesterday. The efficiency program put in place by Sergio Marchionne is bearing fruits, operating margin improved from 5.9% in 2001 to 9.0% in 2002 and there is more to come. We upgrade the stock to buy and increase our price target to CHF510 (from CHF 440), Upgrading to Buy. Top line growth (+2.6% in CHF) was in line with our forecast, organic growth was 6.5%. Our top line growth forecasts for 2003 and 2004 are
unchanged. We do not expect any significant acquisition this year but in 2004, an acquisition in the area of Life Sciences is likely. No acquisitions are currently included in our forecasts.”
5/28/2004:Share Price 726 CHF; Sergio announces resignation as CEO but will remain chairman, having achieved a 12.2% operating margin, more than double that of when he joined, and 22% higher than the ambitious targets he had set 2 years earlier.
4/30/05: Share Price: 805 CHF
Catalyst
-Return of Auto to break even in 2005
-Exercise of convertendo in September
-Formation of partnerships in Auto and steps taken to reduce investor exposure
- Operational improvements at CNH and other divisions and attainment of 2007 targets set forth by CEO