Investors in Fiat S.p.A. (OTCPK:FIATY) reacted with great enthusiasm to the fact that the company gained full control of Chrysler Group LLC. Shares rose some 13% halfway during the European trading session in Milan.
Years after Fiat came to rescue Chrysler, today's situation has largely been reverted with Chrysler being the star performer compared to the struggling operations of the Italian auto maker. Despite Thursday's jump, shares still have a lot more potential going forward, making it a top pick for 2014.
Finally A Deal Has Been Struck After Talks For Over A Year
For $4.35 billion, Fiat will purchase the remaining stake in Chrysler Group which it did not already own. CEO Sergio Marchionne has been busy for over a year to combine both companies.
Marchionne has been very pleased with the deal commenting, "The unified ownership structure will now allow us to fully execute our vision of creating a global automaker."
The price tag for the remainder 41.46% stake in the business being bought from the retiree healthcare trust affiliated with the United Auto Workers union implies that Chrysler is valued around $10.5 billion. The UAW fund will receive $3.65 billion in cash upfront, roughly split in half between a Chrysler and Fiat payment. Chrysler will pay another $700 million in the coming three years to the UAW.
Given the structure of the deal, with a lot of cash being paid by Chrysler itself and a portion being deferred into the future, Fiat will not need to raise capital through a right issue.
Implications For Fiat
Fiat continues to lose a lot of money in Europe, yet the merger could bring technology, cash and dealer networks from Chrysler which could improve the performance in Europe. Given the low upfront capital investment, the fact that no capital raise is required to finance the deal, and the lower than expected price tag, the market is very enthusiastic about the deal.
The 13% jump on Thursday, boosted the market capitalization of Fiat by some $1.3 billion which just testifies to the market's happiness about the deal. The fact that this deal has been closed is kind of a surprise. A Chrysler IPO has been among the options and has been filed last year. The payout to the UAW is a bit disappointing, with the fund seeking more than $5 billion for its stake.
Fiat's Financial Position
In October, Fiat released its third quarter results. For 2013, Fiat now sees full year revenues of around $88 billion. Net earnings are seen between $0.9 and $1.2 billion, while industrial net debt is seen between $7.0 and $7.5 billion. Note that these results include the full contribution from Chrysler.
Trading around $9.50 for the ADR, Fiat's stock is valued at roughly $11.5 billion. Now just realize that the $10.5 billion deal to buy Chrysler has been closed and you realize the potential. Even after the jump, Fiat's own operations are valued at just a billion.
Strong Historical Performance
Between 2009 and 2013, Fiat increased its annual revenues significantly. Revenues rose from $33 billion to $88 billion on the back of the Chrysler deal, while GAAP earnings have been volatile and are seen around $1 billion this year.
As shares traded around $5 in 2012, shares have seen strong returns in 2013, rising by roughly two-thirds to $8.30 for the ADR. Factoring in the huge gains in European trading and the ADRs could advance to $9.50 per share, marking the fact that shares nearly doubled over the past year.
What's Possible Going Forwards?
Marchionne holds a dubious position, having been the top executive of both automakers in the past, while currently holding the CEO title of Fiat. The market is pleased with the prospects that the tie-up allows Fiat to reduce losses in Europe.
On top of that is the superior profitability of Chrysler as the full ownership allows Fiat to integrated finances as well. Note that there appears to be a lot more upside following the deal. The net debt position of around $10 billion for the combined entity is mostly held at Fiat's activities with Chrysler's financial position being in much better shape.
Now Chrysler is the slightly bigger company, reporting solid earnings. At current exchange rates, Chrysler is generating roughly $65 billion in annualized revenues when annualizing third quarter results. Just like its US competitors, earnings have grown more healthy, coming in at an annualized $2-$2.5 billion. This values the $10.5 billion deal at just 0.15 times sales and roughly 5 times earnings. Fiat itself reported revenues of $45 billion this year, while posting a loss of around $1 billion.
To illustrate the potential: After a strong recovery, Ford's (F) equity is valued at $60 billion, or roughly 0.4 times expected revenues of $150 billion. Ford reports net profit margins of around 4%.
Implications For Shareholders
Even if we play it conservatively, there is much more upside for Fiat, especially if the integration can end losses for the old Fiat activities and create a stronger worldwide player.
Note that a conservative and relative valuation versus the likes of Ford, implies that Chrysler could be valued around 10 times earnings, or at just 0.25 times sales. In such an event, the car market could be worth anywhere between $15-$25 billion, much more than the current implied valuation of $10.5 billion.
Fiat's activities are arguably not worth that much. Even when I attach no value to the shares and subtract the net debt position of $10 billion from the combination, then a $5-$15 billion valuation is in line with today's valuation at $11.5 billion. Note that I even attach zero valuation to very interesting assets owned by Fiat, including Ferrari which alone could fetch billions in valuation. Nor have I accounted for any synergies from combining operations.
You get the point, the combination seems very attractive and the current valuation leaves a lot more appeal. Let's start with a $15 price target, placing Fiat among the top picks for 2014.