When you examine Fiat Group S.p.a. ADR (OTCPK:FIATY) you will quickly notice a few anomalies: The firm has both a large amount of debt and a big cash hoard. Growth investors are not in the least interested in Fiat because it has been posting terrible growth numbers for years. Value investors will lose interest on learning about its precarious debt situation. In addition the automaker is located in Italy. A country with a struggling economy to put it mildly. Nobody wants this carmaker.
The company keeps this cash hoard around because management wants to maintain flexibility to strike a good deal to buy the remainder of Chrysler. Right now it owns 59.5% of Chrysler shares and it would like to buy the remaining 41.5%. Fiat acquired a large part of Chrysler during the crisis when U.S. automakers ran into liquidity problems. The United Auto Workers medical trust owns the other part.
This creates an interesting dynamic because management is incentivized to downplay the value of the Chrysler segment. They want to acquire the business at a good price from the trust. The trust in turn wants a good price to cover its liabilities. They threaten to IPO Chrysler if Fiat doesn't come up with a decent price. Meanwhile Fiat has the option to buy the trust's stake for $6 Billion. However it is looking to pay much less for the Chrysler shares. The outlook of the entire business can quickly change when one of two catalysts materialize:
- A good price to acquire the Chrysler shares is negotiated. Afterwards management is fully incentivized to show the value of the Chrysler segment and apply full attention to the integration of the two businesses.
- It becomes clear the remaining shares won't be acquired anytime soon and management can decrease debt with the cash it has on hand. This will remove a significant part of interest costs, decrease leverage statistics and lift a veil of the underlying cash flow. At this point management can also start engaging in aggressive restructuring because the scale advantage it hopes to achieve by combining operations will be out of the question.
Because Fiat is in this atypical and confusing position the market is missing what this mess is really worth.
After thinking about it for a few days, I figured the best way to show Fiat's value is by stripping down the thesis from as much complications as possible to a very simple proposition:
What is the Chrysler Business worth?
It's necessary to put a number on the Chrysler business. IPO advisers were considering a valuation of about $10 billion for Chrysler, according to Bloomberg. Based on those calculations, Fiat is now seeking to pay about $4.2 billion for the holding, compared with the trust's demands for at least $5 billion. Let's value Chrysler at the lower of the two valuations at $10 Billion total. Note that Fiat is motivated to value Chrysler as low as possible to attempt and acquire the remaining shares cheaply.
This puts a number on the Chryler shares owned by Fiat: $5.8 Billion or $4.7 per New York traded ADR of Fiat.
How much cash does Fiat have?
The cash hoard Fiat has accumulated stands at $18.61 per ADR.
How much long term debt does Fiat have?
Meanwhile the company has $30 in debt per ADR.
Fiat stripped to the core
That means you pay $6.69 per ADR of Fiat without Cash, Chrysler and without debt. At 1.22 billion ADR's outstanding that is about $8.16 billion in market cap for a company with estimated yearly revenues around $35 billion and no debt or cash.
If you remember how General Motors (GM) or Ford Motor Co (F) developed over the past few years, it's not a big leap to see a company go from $35 billion revenue and losing money to a situation of 5% net margins. That would put profits at $1.75 Billion.
If that scenario appears feasible, you can buy a company with no debt for 4.2 times forward earnings.
Obviously, an investment in Fiat is not without risk. We have to take a worst case scenario into account and allow for some bad luck. There are however a few emergency exits that aid Fiat shareholders in case of problems.
CEO Sergio Marchionne has managed to keep Fiat's debt structure unsecured, with the ability to sell or distribute assets.
The profitable South American operations of Fiat could be sold to Chrysler and European money losing operations could be terminated. This possibility actually helps Fiat in negotiations with Italian unions and limits the power these have over the automaker's shareholders.
A distribution of Ferrari stock among shareholders is possible and unrestricted by Fiat's bond indentures. Marchione estimated value of the Ferrari business at $7.3 Billion in 2011. Maybe Marchione extremely optimistic there but if Ferrari were sold for anywhere near that number, two years into a bull market later, that covers 90% of the downside by itself. You would still be the owner of the much greater Fiat business.
The Italian automaker Fiat is unloved because it's core operations are losing money. It's home market is in terrible shape. In addition the company carries a huge amount of debt. Truly, not an exciting prospect. Until you learn Fiat owns 59.5% of the profitable Chrysler business. The value of which management would like to downplay until it acquires 100%. In addition there is the cash hoard on its balance sheet. Finally there is downside protection because of the unsecured debt. Fiat can be acquired at a greater discount to intrinsic value than either General Motors or Ford Motors and consequently the potential profit is much greater.